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January’s 7.5-percent inflation pace all but guarantees that the U.S. Federal Reserve will raise its key interest rate next month from the 0.25 percent where the Fed has held it since March 2020.
The remaining variable is the size of the rate hike.
Traditionally, the Fed raises its rate by a quarter of a percentage point at a time.
However, reacting to January’s 40-year record inflation rate, James Bullard, president of the Federal Reserve Bank of St. Louis, suggested the Fed could consider a half-point raise in March and also could raise rates between its scheduled bimonthly meetings.
The central bank has not bumped rates by half a point at a time since 2000.
“We are going to have to be far more nimble and far more reactive to data,” Bullard said in a Bloomberg interview.
“There was a time when the committee would have reacted to something like this by having a meeting right now and raising rates right now,” he said.
On 10 February, the yield on the two-year treasury note—which is finely tuned to potential near-term changes in interest rates—jumped from 1.346 percent to 1.560, the biggest one-day increase since 2009.
A day later, yields on 10-year treasuries broke above 2 percent for the first time since summer 2019.
Also on 11 February, interest-rate futures markets had priced in an almost 50-percent probability that next month’s rate hike will be greater than 0.25 percent, compared with a 25-percent probability that prevailed two days earlier.
The probability rose to 90 percent late in the day after Bullard’s comments were publicized.
Clogs in the global supply chain will continue to drive inflation through the first several months of this year, Fed chair Jerome Powell said in a press briefing last month.
“The Fed is deeply behind the curve on inflation,” Timothy Duy, chief economist at SGH Macro Advisors, said to The Wall Street Journal. “There is no other story at this point.”
Seven Shot
Traders are betting that the U.S. Federal Reserve will raise interest rates by 0.25 percentage points seven times this year, Bloomberg reported.
Goldman Sachs agrees, upping its forecast to seven Fed rate hikes instead of the five it had predicted in December.
Bank of America’s analysts predict seven rate bumps this year and another four in 2023.
Pricing of overnight index swaps on 11 February showed traders expect the Fed’s main interest rate will end the year at 1.84 percent, compared to the effective 0.08 percent it holds today.
Yields on 10-year treasury bonds briefly zoomed to 2.05 percent on 11 February before settling back to close at 1.92 percent. The rate had broken through 2 percent the day before for the first time since 2019.
Bond yields rise as bond prices fall.
Last week’s developments pushed yields for two-year bonds higher, as those are sensitive to Fed policy shifts. The rise in yields narrowed the gap between yields on five-year and 30-year bonds, a shift that indicates traders expect economic growth to slow.
Inflation is nearing its peak and will ease down to 4.8 percent this year and 2.4 percent by the end of 2023, according to traders and analysts Bloomberg surveyed.
TREND FORECAST: After too many months of ignoring inflation to nurture the equity market rise and artificially boost the economy, the Fed must now run to catch up.
If February’s inflation rate remains above 7 percent, the Fed is more likely to raise its base interest rate by half a percentage point. If inflation eases back under 5 percent this month, The Street will bet that the Fed will stick with a quarter-point bump and monitor the economy’s reaction while it prepares for decision-time in future meetings.
However, we expect sharp interest rate rises which will hit the economy in the late third quarter and for the Fed to sharply lower interest rates in the run up to the 2024 Presidential Reality Show®.