Hot US inflation fuels expectations of supersized Fed rate hike

WASHINGTON: The US Federal Reserve (Fed) is seen ramping up its battle with 40-year high inflation with a supersized 100-basis point rate increase this month after a grim inflation report showed price pressures accelerating.

“Everything is in play,” Atlanta Fed president Raphael Bostic told reporters in Florida, when asked about the possibility.

While he said he still needed to study the “nuts and bolts” of the report, “today’s numbers suggest the trajectory is not moving in a positive way … how much I need to adapt is really the next question.”

Bostic has been among the group of central bankers in recent weeks signalling support for a second straight 75 basis points rate increase at their upcoming policy meeting on July 26-27.

But after yesterday’s (July 13) data from the Labor Department showed rising costs of petrol, food and rent drove the consumer price index (CPI) up 9.1% last month from a year earlier, views may be evolving.

Traders of futures tied to the Fed’s policy rate are betting they already have: They are now pricing in a nearly 80% probability of a full percentage-point rise at the coming meeting, according to an analysis of the contracts by CME Group.

That was up from about a one-in-nine chance seen before the report, which also showed core inflation, excluding more volatile food and energy prices, accelerated on a monthly basis.

The expectation that the Fed will get more aggressive to stop inflation is also raising alarm that policymakers will go too far and crater economic growth as well.

Yields on longer-term Treasuries fell, making the so-called yield-curve inversion the most pronounced it has been in more than 20 years.

An inversion is seen as a harbinger of a downturn because it suggests investors are banking on a growth slowdown. Rate futures trading suggests investors anticipate the Fed may need to start cutting interest rates again by the middle of next year.

“The June CPI report was a straight up disaster for the Fed,” wrote SGH Macro Advisors’ Tim Duy. “The deepening yield curve inversion is screaming recession, and the Fed has made clear it prioritizes restoring price stability over all else.”

Other central banks are also feeling the heat with the Bank of Canada yesterday raising its benchmark interest rate by 100 basis points in a bid to tame soaring inflation, a surprise move and its biggest in nearly 24 years.

The persistence of such high inflation and the strength of the US central bank’s moves needed to quash it are also once again sharpening fears a recession is on the horizon.

A Fed survey of firms across the US published later yesterday showed increased pessimism on the outlook for the economy, with almost half of the central bank’s districts reporting firms seeing an increased risk of a recession, while substantial price increases were reported across all districts with “most contacts expect(ing) pricing pressures to persist at least through the end of the year”.

Fed research published this week based on modelling of bond-market yields puts the chance of a recession next year at about 35% if the Fed sticks to its expected baseline rate-hike path, but at 60% if the Fed removes accommodation faster.

“With supply conditions showing little sign of improvement, the onus is on the Fed to hit the brakes via higher rates to allow demand to better match supply conditions. The recession threat is rising,” said James Knightley, chief international economist at ING. – Reuters