The Federal Reserve’s war on inflation isn’t over. After five days of turmoil in the banking sector, financial markets had all but written off the prospect of additional interest-rate increases. But the latest consumer price index shows why that assessment was premature.
The new numbers Tuesday showed the core CPI rose 0.5 percent from a month earlier, exceeding (albeit only slightly) the median forecast of economists in a Bloomberg survey. On a three-month annualized basis, the report put core CPI at around 5.2 percent, highlighting the challenge facing the Fed as it tries to juggle both sides of its inflation and full employment dual mandate.
Until last week, expectations for higher rates were hardly even up for debate, but the collapse of Silicon Valley Bank triggered a widespread and swift reassessment, with yields on two-year notes plummeting 109 basis points in three trading sessions. Goldman Sachs Group Inc. and Barclays Plc economists changed forecasts to reflect no change by the Fed at its meeting next week, while Nomura Securities economists went further to say the Fed would even cut rates and stop quantitative tightening. Doing so would be a complete about-face for a central bank that, as recently as the middle of last week, had actively floated the possibility of a 50-basis-point increase to a range of 5 percent to 5.25 percent.
With the new CPI data in hand, it’s unlikely that the Fed will make such a drastic reassessment of its path. As Tuesday’s report showed, inflation remains widespread in the US economy, and suspending the fight now would risk undermining the Fed’s credibility.
For months, Fed Chair Jerome Powell has directed traders’ attention to a bespoke index known as core services excluding shelter, which could indicate high overall inflation even though core goods have crested and a cooling of housing costs appeared to be in the cards. In February, that metric accelerated slightly to 0.5 percent, putting it around 5.1 percent on a three-month annualised basis. Within that closely watched category, transportation and recreation services inflation both accelerated.
But making policy on that basis would be tantamount to returning to the days of giving inflation data the benefit of the doubt, and we all know how that worked out: The Fed waited until March 2022 to address a problem that was already evident in late 2021. Now, if the data is a toss-up, the Fed’s risk-management approach would call for taking the more proactive approach to inflation.
The other problem with suspending the inflation fight now is the message it would send about financial stability. Shifting gears would tell the world that the steps taken during the weekend to backstop banks aren’t enough and that serious damage to the economy is already inevitable. Normally it takes rate cuts to cement the perception of an economic calamity, but with inflation as high as it is, giving up the fight against high and volatile prices would send the same message: “Look out below.” If the Fed knows something we don’t about the risks ahead, then by all means it should back off at once. But as New York Fed President John Williams said in prepared remarks last November, monetary policy shouldn’t be viewed as the singular fix for every ailment: Everyone is familiar with the idea of a “jack of all trades.“ Using monetary policy to mitigate financial stability vulnerabilities can lead to unfavorable outcomes for the economy. Monetary policy should not try to be a jack of all trades and a master of none. There must be a better way.
That echoed a similar sentiment from Fed Governor Christopher Waller in October (resurfaced in a recent article by the Wall Street Journal’s Nick Timiraos):
"I’ve read some speculation recently that financial stability concerns could possibly lead the FOMC to slow rate increases or halt them earlier than expected. Let me be clear that this is not something I’m considering or believe to be a very likely development. ... Along with the improved regulatory framework, I believe we have tools in place to address any financial stability concerns and should not be looking to monetary policy for this purpose. The focus of monetary policy needs to be fighting inflation."
Common sense now favors a 25-basis-point increase in the Fed’s target range next week. A lot can change in the next eight days — including banking sector developments and important data on producer prices, retail sales and consumer sentiment — but suspending the inflation fight now looks as if it would undermine the Fed’s credibility, and when the signaling effect is taken into consideration, the outcome for financial stability would probably be a wash at best.
Jonathan Levin has worked as a Bloomberg journalist in Latin America and the U.S., covering finance, markets and M&A. Most recently, he has served as the company's Miami bureau chief. He is a CFA charterholder. Views are personal and do not represent the stand of this publication.
Credit: Bloomberg
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