Sitting out the oil shock may not be enough. The Federal Reserve may now have to prove it will act to meet its inflation target, much as its counterparts in Europe seem determined to do. Given what Wall Street forecasters currently think, that could pack quite a punch if it happens.
Year-end crude oil futures are near their highest level of the Iran war so far, and with little sign of a durable peace deal. April U.S. inflation data this week showed the mounting damage to already above-target prices.
Annual consumer price inflation is heading back above 4% this month for the first time in three years, having failed to hit the Fed’s 2% target rate since February 2021. Producer prices twisted the knife, clocking their biggest monthly gain since the aftermath of Russia’s invasion of Ukraine in March 2022 and an annual rate of 6% – the highest in over three years.
Slice and dice the numbers a hundred ways, but few doubt that core inflation, and even “trimmed-mean” inflation rates that strip out the more extreme monthly price moves, are back on the rise. The trend has turned higher again, and so has the momentum of price changes.
Many of the regional Fed presidents feel the central bank’s inability to get back to its target risks shredding its credibility longer term, and could push market and public inflation expectations even higher.
Boston Fed President Susan Collins is the latest to fret.
“More than five years of above-target inflation has reduced my patience for ‘looking through’ another supply shock,” Collins said on Wednesday. “I could envision a scenario in which some policy tightening is needed to ensure that inflation returns durably to 2% in a timely manner.”
Collins is not alone. This year’s more hawkish voters on the Fed’s policymaking council echo that view.
Cleveland Fed President Beth Hammack, for example, was one of three policymakers who dissented from the easing bias in the Fed’s last statement.
“Our statement should have a pretty neutral stance about whether the next move is down or up or just on hold for a really long period of time,” she said last week.
Talk of a split central bank as new Chair Kevin Warsh takes over this week merely disguises the hawkish tilt. Of 18 Fed board members and regional presidents, only three are currently considered dovish by many Fed-watchers.
And Warsh replaces just one of those doves on the board.
THE ONLY WAY IS UP?
If a prolonged energy squeeze seeps further into core goods and services prices, how likely is it that the next Fed move is up?
A Fed futures market that confidently bet on two more rate cuts right up until the attacks on Iran in late February currently sees no further easing and puts an 80% chance of a 25-basis-point rise in the 3.625% policy rate over the next 12 months.
Two-year Treasury yields topped 4% again this week. The 30-year bond yield is back above 5%, and average 30-year fixed mortgage rates stand at 6.46% – above 6% for nearly four years straight.
The fixed-income market is already bracing for a change of direction in Fed policy – and not the one most had envisaged when Warsh was first nominated in January.
Yet the persistence of rate-cut forecasts suggests the wider investment world still treats further easing as its base case – presumably assuming an end to the Gulf conflict and a retreat in oil prices will reopen the Fed door.
Just three weeks ago, only one of 62 economists and strategists polled by Reuters expected a rate rise by the middle of next year. The median view was for two more cuts over that time.
This week, even as lousy inflation data forced many banks and forecasters to push back their easing timelines, rate cuts remain in the mix.
UBS Global Wealth Managementpushed its expectation for the next cut back by three months to September, but still expects two cuts in December and March next year.
Morgan Stanley’smid-year outlook still pencils in a Fed cut next year, alongside an 11% rise in the S&P 500 and a retreat in 10-year Treasury yields to 4.2%.
Of course all these investment houses hedge with alternative scenarios – understandable given the geopolitical unpredictability at hand.
But even though the rates market may have partly repriced, there will have to be a tsunami of forecast changes if the next Fed move is indeed up.
-Reuters
