For nearly six months now, investors have operated with one assumption leading to one single question: when, not if, the Federal Reserve will finally pivot and begin slashing interest rates. And while Treasury‘s futures seemed to ignore the central bank’s repeated assertions all winter long, investors have finally fallen in line with the Federal Open Market Committee’s projection that it will only cut rates three times this year, not twice as many, as investors deluded themselves into believing as late as this January.
But the recent bevy of abysmal inflation reports raises an opposite possibility: that it’s not a matter of when the Fed lowers interest rates but rather if it raises them again.
To be clear, the Fed will fight tooth and nail to avoid this option. Between the bipartisan bullying of both former President Donald Trump and Sen. Elizabeth Warren (D-MA), Fed Chairman Jerome Powell has made it a priority to insulate the Fed from the political creep coming for the rest of the federal bureaucracy. He has tried to vehemently reject calls to cut rates for the sake of the incumbents on ballots, and as importantly, he has lambasted efforts by progressives to add climate and racial justice concerns to the Fed’s congressionally authorized mandate. As a part of this pursuit to repel accusations that the Fed is biased in either direction, it is likely praying that the soft landing continues apace, allowing it to do the three rate cuts it has promised, no more and no less.
But the data is no longer teetering between “good enough to cut rates” and “not quite yet.” Rather we now have to wonder whether inflation is slowing anymore at all.
Consumer price index inflation is back on the rise to an annual rate of 3.2%, and core CPI has stagnated at 3.8%. Both came in at 0.4% last month, or more than twice the Fed’s maximum target. Only personal consumption expenditures and core PCE are trending slightly in the right direction, at 2.4% and 2.8%, respectively.
But wholesale prices are leading indicators of consumer inflation, and they indicate that progress is not just slowing but reversing. Producer price index inflation blew past economist expectations, jumping from 1% annually in January to 1.6% in February. Core PPI came in even higher at 2%.
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A month ago, investors were expecting a rate cut as early as March. Now, they’ve priced out the likelihood of one coming even in June. While the Fed will be happy enough to wait out the data and keep rates higher for longer, as they’ve made their mantra, the very real possibility persists that inflation continues to accelerate, putting them in the quandary of whether they have to hike rates, let alone toss their expectations of three rate cuts more generally.
If this happens, it will indeed be due to the explicitly inflationary policies of President Joe Biden, who has expressly worked against the Fed’s attempts to restrict the money supply. And if this happens, look to see whether Democrats blame Powell rather than Biden for being forced to raise rate in an election year.
