Hot inflation and strong economic data add turbulence to Fed’s fight
Corporates | Kennett Square, PA
In a short week, FOMC minutes were released detailing the pace of rate hikes to combat inflation. New economic data maintained the strong labor market view and tenacious inflation data indicated the Fed’s fight could be prolonged. The war in Ukraine has led to a battle over oil supply; natural gas producers cut production forecasts amid low prices.
Federal Open Mark Committee (FOMC) minutes were released on Wednesday. Details of the Fed officials’ meeting at the beginning of the month showed most officials agreed that slow and moderate rate increases were key to achieving a soft landing. The minutes also unveiled that some officials would have agreed to a half-point increase rather than the quarter-point increase that was unanimously voted upon. As the voting is decided upon by only members of the rate-setting committee, non-voting member James Bullard, the St. Louis Fed President, believed in a steeper hike to reach the estimated peak level at nearly 5.4%. “I don’t see much merit in delaying our approach to that level,” he said. In the wake of last week’s data, some analysts argue in favor of Bullard’s sentiment. Data released showed that in January CPI increased by 0.5% rather than expectations of a 0.4% increase, retail sales increased by 3% instead of expectations of a 1.9% increase, and unemployment reached a 53-year low. Further, data released Thursday by the Labor Department showed a tight labor market as weekly initial jobless claims decreased by 3,000 to a seasonally adjusted 192,000. Yet the biggest blow to the Fed’s fight came on Friday when the personal-consumption expenditures (PCE) price index was shown to rise 5.4% in January from a year prior. The core PCE index was also revealed to exceed expectations at a 4.7% increase. The PCE index is the Fed’s preferred measure of inflation, and the central bank is targeting an annual inflation rate of 2%. Equities fell sharply with the PCE news, marking the worst week of the year, and treasury yields climbed. With strong economic conditions, the challenge to reduce inflation with a soft landing could last longer than expected.
Following these headlines, the market is now pricing in a 41.7% chance of a 50-basis-point increase at the next FOMC meeting according to the CME FedWatch Tool, highlighting the belief that current interest rates are not high enough to have a cooling effect on either consumer spending or the labor market and more rate hikes are in our future. This shift in expectations provides an opportunity with an inverted yield curve to fix floating rate debt at a rate lower than equivalent debt with a shorter maturity. As market expectations change, corporate treasury teams should evaluate both the financial risks and market opportunities presented.
(Related insight: Watch "Semiannual Market Update for Corporations")
Although it seems that the expected effects of higher interest rates have not yet materialized when looking at consumer spending or the labor marker, effects have been seen in the level of consumer savings which is now lower than pre-pandemic levels. This could be reason for concern in the event of widespread layoffs brought on by further rate hikes, as consumer debt levels have risen and their financial cushion has been eroded.
Oil floats and natural gas deflates
Attention has recently shifted to oil prices as the war in Ukraine reaches the one-year mark. In retaliation to the European Union’s sanctions on all Russian oil products as well as the implementation of a price cap, Russia announced a 5% reduction in oil production in March (0.5% of global supply). This news is paired with rising uncertainty around the pace of China’s reopening and the additional oil demand that would follow.
Prices for natural gas have reached their lowest levels since COVID lockdowns went into effect. After pipelines critical for delivering gas into Europe were damaged last year, prices surged, but have fallen nearly 66% since December. This is largely because U.S. and EU gas demand has been soft in a warmer than average winter. Several natural gas producers, like Chesapeake Energy Corp, recently stated production will begin to slow down as consumers draw upon the surplus of inventory.
The week ahead
This week, be on the lookout for headlines relating to Core Durable Goods Orders and Pending Home Sales today and the release of the Conference Board Consumer Confidence on Tuesday to gain insight into the consumer. On Thursday, the European Central Bank releases February’s CPI data as well as a policy statement. The ISM Manufacturing PMI and the ISM Non-Manufacturing PMI also get released on Wednesday and Friday, respectively.
Subscribe to receive our market insights and webinar invites
Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.23-0047
Our featured insights
Resilience remains: reason to raise rates?
Despite high global inflation and borrowing costs, recent economic releases have continued to show a resilient global economy. This resilience may persuade global central banks to continue to raise interest rates to tame inflation.
- Post Date
- Mar 6, 2023
January inflation data shows the Fed still has work to do
A busy week was highlighted by stronger-than-expected inflation in January. CPI, core CPI, and PPI all exceeded market predictions. Retail sales also shattered expectations, while initial jobless claims totaled less than 200,000 for the fifth straight week.
- Post Date
- Feb 21, 2023
Banks tightened and the market rallied: what’s going on?
The European Central Bank (ECB), Bank of England (BoE), and U.S. Federal Reserve (Fed) all raised their respective benchmark rates last week. The ECB raised rates by 50 basis points to a key rate of 2.5% on Thursday and signaled another 50-basis-point hike was coming at the next meeting in March....
- Post Date
- Feb 6, 2023
GDP, PCE take steps in the right direction ahead of Fed meeting, China’s reopening leads to commodities shift
December metrics for GDP and inflation came in at promising levels, keeping market expectations consistent ahead of this week’s FOMC meeting. China’s reopening leads to increased economic activity, including increased demand for metals and oil, while natural gas struggles due to unexpectedly warm...
- Post Date
- Jan 30, 2023
Retail sales, producer price data suggest cooling economic activity
Markets responded positively to declining PPI and retail sales figures, suggesting that U.S. economic activity, and notably inflation, is slowing. Investors are pointing to the data as another piece of evidence that the Federal Reserve will be able to soften its hawkish stance on rate tightening...
- Post Date
- Jan 20, 2023
Labor market remains stoic as U.S. inflation slows, dollar weakens
The Federal Reserve appears to be in control of inflation after the most recent consumer price index report. Questions linger regarding future rate increases and the subsequent impact on the labor market. The dollar continues its march down from last year’s highs.
- Post Date
- Jan 17, 2023
U.S. jobs market remains strong, nonfarm payrolls data suggest slowing inflation
December payrolls surpassed expectations Friday morning as the U.S. added 223,000 jobs to the economy. While the labor market remains strong, investors noted that wage inflation appears to be easing. On the commodity front, oil and natural gas markets lagged to start the year due to global demand...
- Post Date
- Jan 9, 2023
The market is fighting the Fed yet again
After inflation, retail sales, empire manufacturing, and the Philadelphia Fed business outlook all came in below estimates last week, the market — as evidenced by Treasuries and forward curves — broadly disagrees with the Fed’s interest rate outlook.
- Post Date
- Dec 19, 2022