Most economists now expect the FOMC to implement a third-consecutive 0.75 percentage point rate rise at the very least at its meeting later this month, in a move that would lift the federal funds rate to a target range of 3 per cent to 3.25 per cent.
But on Tuesday, traders in fed funds futures contracts also raised the odds of a full percentage point increase in September to roughly 30 per cent, according to CME Group.
Stocks plummeted as a result, with the S&P 500 down 4.3 per cent in its worst trading day of the year. The Nasdaq Composite dropped by more than 5 per cent. Yields on short-dated US government bonds, which rise as prices fall and are highly sensitive to changes in the policy outlook, also surged.
More likely, however, is that the Fed chooses instead to extend its series of 0.75 percentage point rate rises beyond this month and maintain interest rates at a level that restrains economic activity for longer.
“This [CPI] number is more about December than it is about anything else,” said Tim Duy, chief US economist at SGH Macro Advisors. “We’re not seeing enough of the results of monetary tightening showing up in the economy to think that the Fed’s job is anywhere near done.“
Futures markets now point to the benchmark policy rate rising to above 4 per cent by year-end, before peaking at about 4.3 per cent in March 2023.
“The more likely outcome here is that we get big hikes for longer,” said Jonathan Millar, a former Fed economist now at Barclays.
However, economists’ primary concern is that expectations of future inflation could spiral out of control, setting off a feedback loop whereby workers demand higher wages and businesses are forced to continue raising prices, leading to higher overall inflation.
Diana Amoa, chief investment officer at Kirkoswald, warned that outcome is becoming more plausible the longer inflation remains elevated.
While the jump in inflation figures comes as a blow to the Fed, it vindicates officials’ decision to set a high bar for reconsidering their approach to monetary policy – not least because they have been wrong-footed by price rises in the past.
Fed governor Christopher Waller vowed last week not to repeat previous mistakes, pointing to a temporary dip in inflation last summer that went on to become the worst problem the central bank has seen in four decades.
“The consequences of being fooled by a temporary softening in inflation could be even greater now if another misjudgment damages the Fed’s credibility,” he said.
“So, until I see a meaningful and persistent moderation of the rise in core prices, I will support taking significant further steps to tighten monetary policy.“
More specifically, Roberto Perli, a former Fed staffer who is head of public policy at Piper Sandler, said monthly inflation figures will need to fall to a level that amounts to a less than 3 per cent annualised pace on a sustained basis. Monthly core CPI is currently annualising at 6.4 per cent.
“We’re just not even remotely close to what the Fed wants to see,” said Mr Perli. “The more reports like this we get, the farther out the possible pause or pivot is going to go.“
Stocks plummeted as a result, with the S&P 500 down 4.3 per cent in its worst trading day of the year. The Nasdaq Composite dropped by more than 5 per cent. Yields on short-dated US government bonds, which rise as prices fall and are highly sensitive to changes in the policy outlook, also surged.Previous