by Wolf Richter, Wolf Street:
Surly frustrated central bankers telling euphoric markets that the inflation fight is far from over.
The Federal Reserve, the European Central Bank, and the Bank of England have rate-hike meetings over the coming days. And markets have set out to fight all of them. Of the two big ones, the Fed will speak on Wednesday, February 1; the ECB on Thursday, February 2. And this may turn out to be a hoot.
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The ECB, which is far behind the Fed in its rate hikes and has an even bigger inflation problem on its hands, has laid out a course of rate hikes that is far steeper than markets have priced in, to the point where ECB president Christine Lagarde warned markets 10 days ago to “revise their positions,” and markets have blissfully brushed it off.
In terms of the Fed, ever since the initial lift-off rate hike less than a year ago, there have been Fed-pivot bets for a few meetings out. And they all got smacked down. But this time, the rate-cut bets are huge, practically begging for an epic smack down.
The Fed will not release at this meeting any updated projections, including the infamous “dot plot” that indicates where Fed governors see the future path of its policy rates. It releases those projections only at the four meetings that fall near the end of the quarter. The last one was released at the December meeting. The next one will be released at the March meeting.
At every single meeting since the fall of 2021, the Fed was more hawkish than at the prior meeting by projecting higher rates for longer. It has tightened the screws at every meeting. At the December meeting, the Fed projected for the first time that it would hike its policy rates above 5% and that there would be no rate cuts in 2023. Since then, every single Fed governor to speak on the topic emphasized: No rate cuts in 2023. No way Jose, the markets are saying.
It is widely expected that the Fed will hike by 25 basis points on Wednesday, bringing the upper end of the target range to 4.75%, far higher than projected a year ago. The dot plot released after the December meeting showed that a majority of the participants projected 75 basis points of hikes in 2023. This would be a 25-basis-point hike on Wednesday, one in March, and one in May. And then a pause for the rest of the year to see where inflation is going.
There seems to be no consensus at the Fed about the upcoming rate hike. Some governors came out in support of a 25-basis-point hike, others said that for them a 50-basis point hike is also on the table. The meeting could end with some dissenting votes, whichever way it goes.
The projections of 75 basis points in hikes this year and then a pause into 2024 will depend on inflation data showing “compelling” evidence, as the Fed keeps saying, that the core PCE price index, which is the reference index for the Fed, is heading back to 2%.
But on a month-to-month basis, the core PCE price index re-accelerated in December, though year-over-year it slowed to 4.4%. The PCE price index for services re-accelerated as well month to month, and year-over-year hit a new four-decade high. So, this was a step in the wrong direction.
Inflation has come down from the peak due to the plunge in fuel and a drop in durable goods prices. But it’s still very high, gasoline prices are already surging again, durable goods prices won’t drop forever, and inflation in services is red hot.
Inflation has a habit of dishing up nasty surprises. The Fed knows it, has repeatedly pointed at the upside risks to inflation, and has repeatedly emphasized the need to see “compelling” evidence that inflation has been squashed before rate cuts begin.