A one-two punch of reports of high inflation in January is upping the odds that the economy will crater into a recession as the Federal Reserve appears poised to tighten monetary policy further.
Last month, it appeared that the Fed might be poised to pull off an elusive “soft landing,” a scenario in which Fed Chairman Jerome Powell is able to guide the economy away from a recession while simultaneously driving down inflation. That possibility looks less hopeful now.
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This week’s latest producer price index report showed that from December to January, wholesale prices rose 0.7% — the largest one-month inflation since June of last year and an increase that would translate to an annual rate of nearly 9%. Annual inflation fell slightly less than expected to 6%.
Last week’s consumer price index report, the more widely tracked inflation gauge, showed that annual inflation slowed to 6.4% in January — indicating that inflation isn’t cooling as much as economists have been expecting it to despite a yearlong barrage of interest rate hikes that have the chance to tip the economy into a recession.
The signs of persistent inflation mean that more rate hikes are coming from the Fed. Some investors had previously thought that, after raising interest rates by a quarter of a percentage point at its last meeting earlier this month, the Fed would even forgo a rate hike at its next meeting. Those hopes have now been kicked to the curb.
Additionally, just a very small number of investors were predicting an even more aggressive half-point hike in March, but with the inflation reports, that scenario becomes even more likely.
The “renewed inflationary pressure" from the two reports this week "will force serious consideration of adding another rate hike in the first half of 2023, which would also match the Fed’s unrelenting signals that they do not consider inflation’s threat to the economy to be extinguished as yet,” said PNC senior economist Kurt Rankin.
One month ago, investors were putting the odds of the Fed holding off hiking at all in March at a notable 20%, according to CME Group’s FedWatch tool, which calculates the probability using futures contract prices for rates in the short-term market targeted by the Fed. Now the numbers suggest a 0% chance of that occurring. Around 82% now expect a conventional quarter-point increase, while more than 18% are betting that the Fed will ramp up its monetary tightening and raise rates by half of a point.
Markets would undoubtedly react negatively to a half-point hike because it shows that the Fed will be extending the timeline for its rate-hiking cycle, meaning higher borrowing costs and slowing consumer demand will be longer than anticipated just a few weeks ago.
The uncomfortable inflation reports are also bad news for President Joe Biden and his administration.
Biden’s second State of the Union, which occurred amid encouraging inflation readings last month, was heavy on optimism. He spoke about how inflation was falling and gas prices were moderating — although both were higher than when he was sworn into office. Now the White House is attempting to emphasize declines while also acknowledging that the country is not out of the woods quite yet.
“There is still more work to do as we make this transition to more steady, stable growth, and there could be setbacks along the way,” Biden said after the disappointing CPI numbers were released. “That is why my unwavering focus is on continuing to lower costs for families, rebuild our supply chains, and invest in America.”
His approval on the economy is below 38%, and 58% of people disapprove of the way he has handled the economy, according to the RealClearPolitics average. That is 6 points below his overall approval rating.
Republicans have placed the blame for inflation on Biden and the Democrats. Republicans have branded the phenomenon “Bidenflation.” After this week’s PPI report, House Ways and Means Committee Chairman Jason Smith (R-MO) released a statement condemning the high prices and their effects on consumers.
"President Biden’s State of the Union misled the American people about the strength of our economy and the roots of this crushing inflation, and now families trying to buy necessities are being forced to pay the price. The President has prolonged the worker shortage, recklessly fueled inflation, forcing the Federal Reserve to raise interest rates, and attacked America’s energy supply," said Smith.
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And inflation has had a profound effect on the economic landscape. Using the most recent CPI numbers as a guide, poultry prices have risen by more than 11% over the past year, dairy prices are up 14%, a head of lettuce is 17% more expensive, butter and margarine have ballooned by some 33%, and egg prices have skyrocketed by more than 70%. Energy prices are also up, with energy services being 16% more expensive and consumers paying 27% more for piped utility gas.
The Fed’s next meeting is set for March 21. Fed officials will be watching closely to see whether inflation continues to be stickier than expected in February and whether the labor market continues to be strong.