Investors ‘Losing Confidence’ After Latest Inflation Surge—How Aggressive Could Rate Hikes Be?

Topline

As markets grapple with concerns about how quickly the Federal Reserve will reverse its pandemic-era policy, investment banks are warning clients the central bank may need to move more aggressively than expected to combat the surge in consumer prices, with some experts projecting as many as seven interest rate hikes this year—more than double what many Fed officials forecast.

“Fed rhetoric in recent days continues to be puzzling,” one analyst wrote as stocks plunged this … [+] week.

Key Facts

“Inflation is here, and it continues to make its presence known everywhere,” Bank of America economists wrote in a Thursday note, calling January’s “striking” consumer price data, which showed the highest inflation in nearly 40 years, a “wake-up call” for the Fed and predicting officials will hike interest rates by 25 basis points seven times this year.

Goldman Sachs economists issued a similar projection hours later, raising it’s expectations to seven consecutive 25-basis-point hikes at each of the remaining monetary policy meetings this year, compared to five hikes previously projected.

In an even more hawkish stance, Bank of America said in a follow-up note Friday morning that it sees a “good case” for one or two 50 basis-point hikes “out of the gate”—a more-aggressive move several top Fed officials have yet to embrace due to lingering concerns over the pandemic.

“Fed rhetoric in recent days continues to be puzzling,” wrote Bank of America’s Ethan Harris, pointing out some officials, such as Atlanta Fed President Raphael Bostic, still only project three 25 basis-point hikes this year despite also acknowledging the Fed has yet to decide whether it will raise rates by 25 or 50 basis points at its next meeting in March.

Goldman on Thursday said it also “sees the arguments” for a 50 basis-point hike next month, calling the current level of the funds rate “inappropriate” and adding that fears stemming from the combination of very high inflation and hot wage growth “deserve to be taken seriously.”

Investors, meanwhile, seem to be “losing confidence in the Fed,” eToro analyst Callie Cox said in emailed comments Friday, pointing out stocks have plunged since Thursday over concerns the central bank could act aggressively in March, or even call an emergency meeting to raise rates ahead of schedule—something that hasn’t been done since 1994.

Key Background

Trillions of dollars in unprecedented government spending helped keep the economy afloat during the pandemic, but levels of historically high inflation have rattled the market in recent months—and even more so in the new year. The benchmark S&P 500 index is down nearly 7% this year amid growing concerns over interest rate hikes, which tend to hurt company earnings and stock prices. “The Fed has a very narrow path to guide the economy back to one where inflation is lower but growth does not slow meaningfully, and I think that the path got even narrower” after the latest inflation data, Deutsche Bank chief U.S. economist Matthew Luzzetti told Politico on Friday.

Contra

On Thursday afternoon, Fed President James Bullard became the first central bank official to openly endorse a 50-basis-point hike in March. “I was already more hawkish but I have pulled up dramatically what I think the committee should do,” Bullard said after the January inflation report, adding that he would “like to see” hikes totaling 100 basis points by July 1. He also raised the possibility of the Fed being open to an emergency rate increase, stating “there was a time when the committee would have reacted to something like this by having a meeting right now… I think we should be nimble and considering that kind of thing.” Goldman says if another official joins Bullard in becoming more hawkish, it would reconsider its forecast for seven 25-basis-point hikes this year.

Chief Critic

“I don’t think there’s any compelling case to start with a 50 basis point [hike]. We’ve got to be a little bit careful,” Cleveland Fed President Loretta J. Mester said Wednesday. “Even though you can well telegraph what’s coming, when you take that first action, there’s going to be a reaction.”

What To Watch For

A detailed summary of last month’s Fed meeting is set to be released next Wednesday and should provide more clarity on how officials plan to navigate the decades-high surge in inflation. The central bank’s next two-day policy meeting is slated to end on March 17.