Friday's Market Minute: Inflation And The Monetary Conundrum

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Yesterday’s CPI print showed U.S. inflation jumped to a new four-decade high as supply chain issues persist. The broad U.S. consumer is clearly weakening as non-discretionary costs for rents, electricity, energy, and food prices continue to trend higher. Equity and fixed-income markets reacted accordingly, with both bonds and stocks lower. The yield on 10-year Treasury topped 2% for the first time since July 2019 and the 2-year Treasury yield rose to its highest level since January 2020, up on the day to a high of 1.59%. Fed funds futures also traded erratically, with an increased probability of a nonstandard 50 basis points (bps) hike in March stirring up a debate over the possibility that the Fed will be too aggressive. Cutting rates by 50 bps from a high level is not a rare occurrence, but the Fed hasn’t raised rates by a half percentage point since May 2000. At that time, the base policy rate went from 6% to 6.5%.

The labor market is tight and inflation is clearly hot, which places the Federal Reserve in an awkward position with an interest rate hike over a month away. After all, the Fed is still buying bonds as part of its ongoing QE, which is expected to conclude in early March. In the coming weeks, investors and the economy may face a monetary conundrum of the Fed hiking rates even as the Fed is still easing monetary policy through QE. Since the higher-than-expected inflation coupled with more moderate spending indicates that economic growth will cool, the Fed would be tightening conditions to contain supply-side inflation which the Fed has no control over. 

While it is possible the CPI report increases the probability that the U.S. Federal Reserve hikes its policy rate by 50 basis points in March, the Fed would prefer to hike sequentially at consecutive meetings instead of making a more abrupt adjustment. Nevertheless, this inflation print will likely make it more challenging for the Fed to push back against market pricing.

Image credit: Inflation by Nick Youngson CC BY-SA 3.0 Pix4free

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.