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Market Extra: ‘Catastrophically bad’ inflation report is boosting chances of a 75 basis point hike in June or July

Friday’s consumer-price index report for May — which showed the annual headline U.S. inflation rate climbing to 8.6% in May, with few signs of peaking — is boosting the chances of a jumbo-sized rate increase by policy makers as soon as next week, and eliciting dire warnings policy makers have completely lost control of price gains.

Fed funds futures traders now see an 18% chance of a 75 basis point hike in June, up from just 3.6% on on Thursday, according to the CME FedWatch Tool. Economists at Barclays
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backed up the shifting expectations, saying, “we think the U.S. central bank now has good reason to surprise markets by hiking more aggressively” at the June 14-15 meeting, though “it is a close call” and “could play out in either June or July.”

Beneath the issue of where the Fed goes from here is a much more fundamental and serious problem: Some observers fear the U.S. central bank has already effectively lost control of inflation. May’s price gains were broad-based — hitting everything from shelter to gasoline and food, as well as the narrower gauge that excludes food and energy. The data was “catastrophically bad” for both the Fed and Americans alike, said Nancy Tengler, chief executive and chief investment officer of Nashville-based Laffer Tengler Investments, which oversees $1.1 billion.

“What we saw in this report which was disappointing and a little alarming is that the core reading, excluding food and energy, came in hotter than expected and that’s after we dropped off from a very high number for April 2021,” she said via phone. “This is a much more persistent and stickier kind ofinflation that takes years to work through the system.”

“The Fed has been wrong at every single turn and we should be seeing a 75 basis point hike at the June meeting,” Tengler said. “The question is whether they can surprise and I don’t think we are going to see that. Every time they delay, that allows inflation to run rampant and this raises the odds of recession.” Equity markets will be “ugly and choppy through summer because inflation numbers are not going to improve.”

Indeed, traders of derivatives-like instruments known as fixings have expected a string of annual headline CPI readings that rises to as high as 8.8% in August and September, before settling to 8% for October. Meanwhile, U.S. consumer sentiment plunged to a record low this month.

Below is a roundup of the reaction to Friday’s CPI data:

September outlook

“All in all, the report should be of great concern for the Fed given that price gains in both the headline and the core measures show no signs of abating, and we expect prices to continue to register firm gains in the near term,” TD Securities strategists Oscar Munoz, Priya Misra and others wrote in a note. “We expect the Fed to maintain its aggressive tightening bias in the months ahead, look for the Committee to hike rates by 50bp both next week and in the July FOMC meeting, and believe a 50bp hike in September may not be out of the question.”

Jason Pride, chief investment officer of private wealth at Glenmede, said: “Today’s report should extinguish any pretense that a ‘pause’ in rate hikes will likely be appropriate by the end of summer, as the Fed is clearly still behind the eight ball on bringing inflation under control.”

“Investors should expect the Federal Reserve to continue on its 50-bp rate hike path next week and beyond until inflation shows meaningful signs of decelerating toward the Fed’s 2-3% target range,” Pride said.

May report was a `doozy’

“Today’s CPI report was a doozy,” said Tom Graff, head of investments at Facet Wealth.

“While we knew the headline number would probably come in high due to food and energy prices, consensus was that the month-over-month Core CPI would slow sequentially,” he wrote in an email. “Unfortunately that didn’t happen. Headline CPI came in a full 1% for the month and a 40-year high 8.6% for the year, and core stayed steady at +0.6% for the month and 6.0% for the year.” 

“The most concerning part of this report was its breadth. The monthly number wasn’t driven by a few items. Most of the major categories actually accelerated price increases month-over-month. Most observers agree that broader inflation is more likely to persist.”

Out of control

“Friday’s inflation data suggests the ‘peak inflation’ debate may be premature,” said Nancy Davis, founder of Quadratic Capital Management. “The idea of peak inflation assumes that our supply chain disruptions are over and won’t recur anytime soon and I’m not so sure we can be confident of that.”

“Investors remain too confident that the Federal Reserve will be able to control inflation,” Davis said by email. “We should not take the Fed’s ability to control inflation as a given.”

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