Warm inflation feeds on games of oversized interest rate hikes in the Fed

July 13 (Reuters) – The US Federal Reserve increases the fight with 40-year high inflation with an oversized interest rate hike of 100 basis points this month after a gloomy inflation report showed that price pressure accelerated.

“Everything is at stake,”[ads1]; Atlanta Fed President Raphael Bostic told reporters in Florida when asked about the possibility.

While he said he still needed to study the “nuts and bolts” in the report, “today’s figures suggest that the path is not moving in a positive way. … How much I need to adapt is really the next question.”

Bostic has been among the central bankers in recent weeks who have signaled support for a second straight interest rate increase of 75 basis points at their upcoming board meeting on 26-27. July.

But after Wednesday data from the Ministry of Labor showed that rising costs for gas, food and rent drove the consumer price index (CPI) up by 9.1% last month from a year earlier, the outlook may be developing. read more

Traders of futures linked to the Fed’s key policy rate are betting that they already have: They are now pricing in an almost 80% probability of a full percentage point increase at the next meeting, according to an analysis of the contracts from CME Group.

It was up from about one in nine chances seen before the report, which also showed that core inflation, excluding more volatile food and energy prices, accelerated on a monthly basis.

The expectation that the Fed will become more aggressive in stopping inflation also raises alarms that decision-makers will go too far and crater economic growth as well.

Yields on long-term government bonds fell, making the so-called yield curve inversion the most pronounced it has been in more than 20 years.

An inversion is seen as a warning of a downturn because it suggests that investors are betting on a downturn in growth. Futures trading suggests that investors expect the Fed to start cutting interest rates again by the middle of next year.

“The June KPI report was a direct disaster for the Fed,” wrote Tim Duy of SGH Macro Advisors. “The deeper inversion of the yield curve is a screaming recession, and the Fed has made it clear that it prioritizes restoring price stability above all else.”

Other central banks are also feeling the heat as the Bank of Canada raised its reference rate by 100 basis points on Wednesday in an attempt to curb rising inflation, a surprising move and the largest in almost 24 years. read more

‘RECESSION THREAT RISES’

Fed Chairman Jerome Powell and other decision-makers have become increasingly concerned that business and consumer expectations of a sharp rate of future price increases may be undermined. They have shown that they will react quickly when the data deteriorates.

Ahead of its previous meeting in June, the Fed telegraphed a movement of 50 basis points before turning at the last minute to an increase of three quarters of a point on the back of an inflation report that was worse than expected for May, as well as a low consumer inflation survey the same day.

The persistence of such high inflation and the strength of the central bank’s grip needed to stop it also increases fears of a recession on the horizon.

A Fed survey of companies across the country published later Wednesday showed increased pessimism about the outlook for the economy, with almost half of the central bank districts reporting that companies saw an increased risk of a recession, while significant price increases were reported in all districts with “most contacts expect price pressure to persist at least through the end of the year.” read more

Fed surveys published this week based on modeling of bond market rates put the chance of a recession next year at around 35% if the Fed sticks to its expected baseline growth path, but at 60% if the Fed removes overnight faster.

“With supply conditions showing little sign of improvement, the Fed is responsible for pushing the brakes at higher rates to allow demand to better match supply conditions. The recession threat is increasing,” said James Knightley, ING’s international chief economist.

The Fed began tightening its policy in early March, and has already raised its reference rate for night loans by 1.5 percentage points. The financial markets now predict that interest rates will reach 3.5% to 3.75% by the end of the year, higher than the Fed’s decision-makers themselves predicted just three weeks ago.

A very tight labor market has so far resisted the rapid rise in interest rates, with unemployment at 3.6%, close to a historic low. However, it is seen as a double-edged sword, as it also raises concerns that such competition for labor will eventually have to cool down to curb inflation. read more

The U.S. Senate on Wednesday confirmed Michael Barr, a former finance minister, as the Fed’s deputy chief of staff, filling the last vacant seat on the Fed’s seven-member board. read more

Reporting by Lindsay Dunsmuir and Ann Saphir; Additional reporting by Howard Schneider, David Morgan and Sinead Carew; Edited by Chizu Nomiyama and Jonathan Oatis

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