Despite robust economic data suggesting the Fed raise interest rates to taper inflation, the traditional banking sector is causing it to reconsider.
Inflation modestly decelerated in February but the latest figures probably won’t dissuade the Federal Reserve Board from hiking the interest rates further–despite the recent banking crisis.
The Consumer Price Index, a measure of prices for goods and services, increased to 6.0% for the 12 months ending February, the slowest pace since September 2021, according to the data released by the Labor Department on Tuesday. On a month-to-month basis, the index rose to 0.4%, down from 0.5% in January.
Overall, the CPI and the other economic reports show a still-hot economy and a tight labor market, which would generally suggest to the Fed to increase the interest rates when they meet again next week. However, the recent banking failures are complicating Fed officials’ efforts to cool inflation and raise interest rates. The Fed will decide to either give themselves some time and pause interest rates hikes to see if the banking turmoil eases, or to continue to tame inflation as the economic numbers seem to suggest.
“A 25-basis-point (0.25 percentage point) hike is certainly in the cards, that’s what the market is pricing it,” said Sam Bullard, senior economist at Wells Fargo Securities. “With that being said, I would not be surprised if they went with a pause next week. Again, of the concern…of the financial stability risks out there now.”
Confident the banking disruption will abate so that the Fed could focus on slowing inflation, the three major stock markets were up by the end of the day. The Dow was up by 336.26 points on Tuesday or 1.06%. The S&P 500 gained 64.80 points or 1.68%, and the tech-heavy Nasdaq Composite was up 239.31 points or 2.14%. Additionally, the 10-year U.S. Treasury note rose 0.11 percentage points to 3.69%.
But the market may be showing its hand too soon because cooling inflation has stabilized and monetary policy hasn’t been effective in bringing prices down in the past several months, according to chief economist Stephen Stanley at Santander U.S. Capital Markets LLC. For example, the core CPI index, a better indicator for gauging future inflation, hasn’t eased enough, said Stanley.
The core CPI, which excludes food and energy, climbed 0.5% in February, up from 0.4% in January. Indexes like shelter and household furnishings both rose 0.8% over the month; and airline fares rose to 6.4%, ending four consecutive declines.
Inflation has caused some small businesses’ utility bills to double in the past few months. Mario Longo, who owns and operates an auto repair shop in Brooklyn for over 30 years, said he used to pay around $700 a month on his ConEd bill but now pays twice as much.
Long has also been impacted by the tight labor market. Long has recently been talking to his wife about the rising cost of labor he pays at his garage and how he may have to pass some of that cost onto his customers, “And my wife said ‘yeah’ but you’re going to lose customers.”
Overall, Long claims he lost 20% of sales due to inflation and supply chain shocks in the past 12 months.
The good news for Long, at least for now, is that wage growth cooled in February, which means he may not have to increase his employees’ wages anytime soon. Longo could also benefit from the fact that the energy index fell 0.6% this month, down from a 2% increase in January.
The slightly better inflation numbers come as other figures continue to show a robust economy, especially last week’s job report that showed 311,000 jobs were added in February. As a result, some economists speculate that Federal Reserve Chair Jerome Powell could raise interest rates by 50 percentage points to combat inflation–a point Powell said earlier this month when he met with the Senate Banking Committee.
However, the recent financial instability will likely cause the central bank to discontinue the idea of hiking rates that much. Alternatively, Fed officials could decide to either increase interest rates by 0.25 percentage points or possibly pause any hikes, but doing so could impede the Fed’s ability in getting inflation down to 2% a year.
Pausing any increases in the interest rate by the Fed would provide it some time to assess the banking debacle, but in doing so could cause prices to go up if the central bank doesn’t do anything about inflation. And some small businesses may not be able to afford that risk.
Fed officials are facing headwinds while trying to slow things down. Economists Bullard and Stanley said the Fed will increase interest rates by 0.25 percentage points by the end of next week–barring additional bank failures.
If the Fed does decide to hold rates unchanged, Stanley said clear communication with markets is critical, so that they don’t misinterpret the pause and make bad financial decisions, which could lead to a big whipsaw.