Unexpectedly hot inflation reports for February are further fueling expectations that the Federal Reserve will end up cutting interest rates later than sooner.
This week brought unwelcome news for the Federal Reserve, President Joe Biden, potentially the labor market, and consumers more generally. Headline data from both the consumer price index, which is the most closely watched inflation gauge, and the producer price index, which measures the prices paid by producers, showed inflation ticked up in February.
Inflation tracked by the CPI rose to 3.2% for the year ending in February, the Bureau of Labor Statistics reported Tuesday, an unexpected development. Notably, the Fed wants inflation to run at 2%, and the CPI has had trouble breaking below 3%. CPI inflation has wobbled between 3% and 3.7% since June 2023 but has not once fallen into the 2%-3% range.
The PPI, on the other hand, jumped way higher last month than economists had expected. The index rose to 1.6% on an annual basis, hotter than expected. On a monthly basis, inflation ticked up by 0.6%, double what forecasts were calling for.
Together, the indices suggest that inflation may not be falling from the massive spike of the past few years as quickly as had been hoped a few months ago.
When will the Fed finally cut interest rates?
The biggest question for many economists heading into 2024 was when the Fed would begin cutting rates. Investors had been hoping it happen soon, as lower rates can help spur investment.
At the end of last year, there was an optimistic sentiment on Wall Street that the pivot to slashing interest rates would happen as soon as the Federal Open Market Committee’s March meeting and that 2024 would be marked by some six downward rate revisions.
Now that is certainly not happening.
The anticipated pivot date has been slowly moving further back as the year progresses, and the expectation now, given higher inflation readings, is that it will not happen for months.
Investors now place just under a 60% probability that the Fed will conduct its first interest rate cut at its meeting in June, while there are about 80% odds the Fed will have cut rates by its July meeting, according to the CME Group’s FedWatch tool, which calculates the probability using futures contract prices for rates in the short-term market targeted by the Fed.
It is also worth noting that the probability the Fed still holds rates where they are, 5.25% to 5.50%, until its September meeting has now risen to above 18%, up from just over 9% a week ago before the two most recent inflation reports were released.
Roger Aliaga-Diaz, Vanguard’s head of portfolio construction and chief economist of the Americas, branded the country’s inflation as “stubborn” in a report this week.
He said the Fed will “move cautiously toward its first rate cut — including the possibility of not being able to cut interest rates at all this year.”
Labor market
Despite the stubborn inflation and higher interest rate environment, the labor market is humming along.
The economy beat expectations again in February and added another 275,000 jobs, the Bureau of Labor Statistics reported last week. The unemployment rate is at 3.9%, remaining at a low level by historical standards.
In a more recent gauge, jobless claims, another measure of the labor market, fell to 209,000 last week. They have remained low despite the pressure exerted by high interest rates.
This gives the Fed the ammunition it needs to keep rates higher for longer. If the unemployment situation were to worsen, it would raise questions and calls for the Fed to begin cutting sooner in order to prevent more layoffs and a potential recession. But because the jobs market has remained strong, the central bank has some wiggle room.
Aside from the Fed, the strong labor market is plainly good news for consumers. It means those who want a job, by and large, can find one, buffering workers from some of the pain being caused by…
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