Supersized Inflation

U.S. inflation hit another 40-year high last month, as upbeat demand, rising wages, and pandemic-related shortages continue to fuel rising prices.

On Thursday, the U.S. BLS reported that the Consumer Price Index (CPI) rose 0.6% in January. Excluding food and energy, the core CPI also rose 0.6%. The CPI is up 7.5% versus a year ago, and the core CPI is up 6.0%, both 40-year highs.

The graphic breaks down key categories within the CPI, highlighting that price hikes in consumer good have far outpaced those in services.

Skyrocketing used car prices have been well-documented. Still, if used vehicles (and food/energy) are removed, prices are up a sharp 7.2% versus one-year ago (green line). While price increases in the service sector have been more muted, we are seeing an acceleration. Services rose 4.6% in January versus 4.0% in December (blue line). It’s not as onerous on a relative basis, but services are rising at well above the trend of the last decade.

Overall, it was a discouraging report, and the hotter-than-expected numbers got the attention of investors. You see, if inflation is running at a supersized pace, might the Federal Reserve react with supersized rate hikes?

Sentiment favoring a 50 basis point (bp, 1 bp = 0.01%) increase in the fed funds rate from 0—0.25% increased markedly on Thursday, according to the CME Group. Further, chatter was heard in some corners that the Fed could implement an emergency rate increase prior to its scheduled March 16 meeting.

However, an emergency hike is probably unlikely. Historically, the Fed has been reluctant to surprise on the upside. An emergency increase also risks signaling panic and would reinforce criticism that the Fed is well behind the curve.

Besides, the Fed’s own projections show that inflation is expected to slow sharply this year. An emergency rate hike would cast another shadow on the Fed’s much-maligned inflation-forecasting models and highlight a lack of confidence in its own projections.

Initially, several Fed officials tried to downplay a 50 bp move, according to CNBC, but inflation is high, and the economy is at full employment. As we move forward, the Fed will be walking a fine line: bringing inflation under control without tipping the economy into a recession.