Economists brace for big Fed rate hikes

Economists and investors are prepared for the Federal Reserve’s aggressive interest rate hikes to continue beyond September, after an unexpected jump in monthly inflation revived fears about the US central bank’s efforts to rein in lingering price pressures.

CPI (consumer price index) growth in the country accelerated once again in August, defying expectations for a 0.1% monthly decline, as the sharp drop in energy prices failed to offset rising costs in other countries. sectors. Meanwhile, “core” inflation, which excludes volatile items like energy and food, rose by an alarming 0.6% on the month.

“To call it a disappointment would be an understatement,” said David Rosenberg, chief economist and president of Rosenberg Research. “All we have left is the view that the hawks [do Comitê Federal de Mercado Aberto, Fomc na sigla em inglês] so far they keep getting it right, and they’re in charge.”

He added: “Whatever the recession odds before the CPI, even if that’s not the baseline scenario, those odds have jumped significantly.”

Most economists now expect the Fomc to implement a third consecutive rate hike of at least 0.75 percentage point at its meeting later this month, which would lift the federal funds rate to a range of 3% to 3.25%. %.

But on Tuesday, traders in federal funds futures contracts also increased the odds of a full percentage point increase in September to around 30%, according to the CME Group.

Stocks plummeted as a result, with the S&P 500 down 4.3% on its worst trading day of the year. The Nasdaq Composite is down more than 5%. Yields on short-term US government bonds, which rise as prices fall and are highly sensitive to changes in the policy outlook, also rose.

More likely, however, is that the Fed will choose to extend its series of 0.75 percentage point hikes beyond this month and keep interest rates at a level that will constrain economic activity for longer.

“This number [IPC] It’s more about December than anything else,” said Tim Duy, chief US economist at SGH Macro Advisors. .”

Futures markets now point to an interest rate hike to more than 4% by the end of the year, before peaking at around 4.3% in March 2023.

“The most likely outcome is that we have big increases for longer,” said Jonathan Millar, a former Fed economist now at Barclays.

However, economists’ main concern is that expectations of future inflation could spiral out of control, triggering a feedback loop in which workers demand higher wages and companies are forced to keep raising prices, leading to higher overall inflation. high.

Diana Amoa, investment director at Kirkoswald, warned that this outcome is becoming more plausible as inflation remains high.

While the jump in inflation numbers is a blow to the Fed, it justifies the policymakers’ decision to set a high bar to reconsider their approach to monetary policy — not least because they’ve been duped by price hikes in the past.

Fed Chairman Christopher Waller vowed last week not to repeat past mistakes, pointing to a temporary drop in inflation in recent months that has become the central bank’s worst problem in four decades.

“The consequences of being fooled by a temporary slowdown in inflation could be even greater now if another misjudgment damages the Fed’s credibility,” he said. “So, until I see a significant and persistent moderation in the rise in base prices, I will support the adoption of important additional measures to tighten monetary policy.”

More specifically, Roberto Perli, a former Fed official who is Piper Sandler’s head of public policy, said monthly inflation figures will need to fall to a level that represents an annualized pace of less than 3% on a sustained basis. The monthly core CPI is currently annualizing at 6.4%.

“We’re not even remotely close to what the Fed wants,” Perli said. “The more reports like this we have, the further away a possible break or turn will be.”

Translated by Luiz Roberto M. Gonçalves