The latest US inflation data released on Wednesday showed consumer prices rose more than expected in January, dashing hopes that the Federal Reserve would pivot to cutting interest rates soon.
Inflation Hotter Than Expected
The Labor Department reported the consumer price index (CPI) increased 0.5% last month after gaining 0.1% in December, reflecting rapidly rising costs for rents and food. Economists polled by Reuters had forecast the CPI rising 0.4% in January. 
In the 12 months through January, the CPI increased 5.4% after rising 5.3% in December. The steady increase challenges the Fed’s view that inflation has peaked and vindicates calls by some central bank policymakers for interest rates to rise further.
“The Fed was leaning towards a rate cut in March to shore up a slowing economy, but this hot inflation print kills that idea,” said Cliff Hodge, chief investment officer at Cornerstone Wealth.
Markets Tumble on Rate Hike Fears
The S&P 500 fell 1.11%, the Dow Jones Industrial Average shed 0.46%, and the Nasdaq Composite tumbled 1.59%. Asian and European markets followed Wall Street lower. Japan’s Nikkei lost 0.1%, while benchmarks in Hong Kong and South Korea slid over 1%. 
“This inflation report pours cold water on the market’s hopes for Fed easing anytime soon,” said Ellen Zentner, chief U.S. economist at Morgan Stanley.
Yields on the benchmark 10-year Treasury note jumped to around 3.8% as traders priced in a higher peak for interest rates. The odds of a half point Fed rate hike in March shot above 60%, from about 25% prior to the CPI release. 
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Hawkish Fed Sets Stage for Further Hikes
The hotter than expected inflation data reinforced the Fed’s hawkish tone that interest rates need to rise further to tame inflation running well above the central bank’s 2% target. 
In its policy statement Wednesday following a two-day meeting, the Fed raised its key rate by 25 basis points to a range of 4.5% to 4.75%, the highest since late 2007. Officials also projected at least two more rate hikes this year and said they expect to hold rates higher for longer to curb inflation.
“Ongoing increases in the target range will be appropriate,” the policy-setting Federal Open Market Committee said. That marked a change from December when it said rates would need to rise “sufficiently restrictive” to control inflation.
Fed Chair Jerome Powell emphasized in his press conference that disinflation was “in its early stages” and “we can’t declare victory yet.” He pushed back against calls to start cutting rates soon, stating “it would be very premature.”
Analysts said Powell’s uncompromising message shows the Fed is serious about getting inflation under control, even if that risks pushing the economy into recession.
“Powell is not dovish and he is not pivoting. If anything, his comments reinforced the hawkishness seen in the statement,” said Seema Shah, chief global strategist at Principal Global Investors.
March Rate Cut Now Off the Table
With inflation still running hot, hopes for a Fed policy easing as soon as March have evaporated. Markets are now pricing in rates to peak just below 5.2% in July before cuts materialize later in 2023 or 2024. 
“Markets that were hopeful of Fed easing have to readjust their expectations dramatically,” said Brian Jacobsen, senior investment strategist at Allspring Global Investments.
The renewed focus on high rates rattled stock investors who drove major indexes to strong early year gains on optimism over a soft economic landing.
“This effectively ends the debate about a dovish pivot for at least the next six weeks,” said Art Hogan, chief market strategist at B. Riley Wealth. “And it probably ends the equity rally we’ve seen for the first five weeks of this year.”
Still, some economists believe an imminent recession will eventually force the Fed to reverse course and slash rates before the end of the year to support economic growth.
“The data are screaming recession,” said Joseph LaVorgna, chief U.S. economist at SMBC Nikko Securities. “The Fed will be cutting rates before year-end.”
In the meantime, further market declines may be in store until concrete signs of cooling inflation emerge. Today’s hot CPI print means the path to lower rates just got longer and bumpier.
What’s Next for the Fed and Markets
Key upcoming events that may influence the policy outlook include:
February Jobs Report (March 10): Nonfarm payrolls, unemployment, and wage growth data will provide critical signals on the strength of the labor market and inflation pressures. A blowout number may force the Fed to get even more hawkish.
March CPI Data (March 14): The next inflation snapshot will help confirm if January’s pop was a temporary blip or part of a renewed upward trend. Another high print would reinforce the Fed’s tightening bias.
FOMC Meeting (March 22): The Fed may hike rates by another 25bps or 50bps depending on the data. The updated Summary of Economic Projections and dot plot will recalibrate policymakers’ views.
Q1 GDP Estimate (April 27): First estimate of Q1 economic growth will show if the US has managed to skirt or fall into recession after contracting in Q2 and Q3 2022. Critical for Fed policy expectations later in the year.
The path of inflation and jobs data over the next several months will determine if and when the Fed may be able to pause or reverse rate hikes. For now, today’s hotter than expected CPI print dashed hopes for cuts anytime soon. The central bank appears poised to keep interest rates restrictive for longer until inflation moves convincingly back down toward its 2% goal.
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