Does The Fed Have An Inflation Problem? Not Yet, But The Clock Is Ticking
In the wake of hotter-than-expected inflation in January, the market will be watching closely to assess if the Fed is losing control of the inflation progress made to date.
By James Picerno | The Milwaukee Company | jpicerno@themilwaukeecompany.com
The January report on consumer prices confirmed that inflation remains stubborn. Both headline and core readings of the consumer price index (CPI) rose more than expected for the monthly and annual comparisons. The optimistic view adopted by some analysts is that temporary effects from a variety of factors are to blame (the surge in egg prices due to an avian flu outbreak, for instance). Perhaps, but there are deeper signs that sticky inflation risk is gaining traction. That’s a concern because it may lay the groundwork for an ongoing pickup in pricing pressure if left unchecked.
Start with the fact that core CPI (a relatively robust measure of the price trend) continued to edge higher, rising 3.3% year over year. Although core CPI is holding in the 3%-plus range, it remains well above the Fed’s 2% inflation target.
Looking at a broader measure of inflation metrics, including several indexes published by regional Fed banks, shows pricing pressure is heating up. The average annual change for this expanded set of inflation benchmarks edged higher for a fourth straight month—the longest stretch of back-to-back increases since the pandemic-driven inflation surge in 2021-2022.
Consider, too, that while core CPI for the year-over-year comparison has remained relatively steady, the 3- and 6-month comparisons are starting to turn up. That may be an early sign that inflationary pressures are building and will soon start to lift the 1-year trend above its recent range. In that case, the alarm bells will start ringing, although given the lag time in monetary policy it might be too late to contain an upside breakout by tightening policy.
Another potential warning sign: the 5-year breakeven inflation rate rose to 2.66% on Wednesday (Feb. 12), the highest in nearly two years. Calculated as the nominal 5-year Treasury yield less its inflation-indexed counterpart, this breakeven rate is the market’s implied inflation forecast. The upside bias suggests the Treasury market is starting to worry about the inflation outlook.
It’s premature to start talking about rate hikes, but rate cuts appear to be on pause until further notice. The Fed funds futures market this morning is still pricing in a high probability (97.5%) that the Fed will leave its target rate unchanged at the next policy meeting on Mar. 19, based on CME Group data.
There’s also a political aspect to consider. President Trump’s repeated calls for rate cuts could exert political pressure on the Fed to ease, even amid upside surprises in inflation. Another factor to monitor: the president’s plans for higher tariffs on US imports could lift inflation, if only temporarily.
Keep in mind that the February consumer inflation report is scheduled for release on Mar. 12, a week ahead of the next FOMC meeting. The market will be watching closely to assess if the Fed is losing control of the inflation progress made to date.
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