The sizzling U.S. consumer inflation report for May released Friday was a game-changer for the Federal Reserve, ensuring that the central bank will take a hawkish stance in their decisions on Wednesday, economists said.
“Doves don’t exist on the committee right now,” said Rob Dent, U.S. senior economist at Nomura, in an interview.
Instead of showing signs of moderation, as had been expected, consumer price inflation actually accelerated to a 1% gain in May, pushing up the annual rate of inflation to a 40-year high of 8.6%.
See: Rising rents, gas and food prices push U.S. inflation to 40-year high of 8.6%, CPI shows
“They don’t really have a choice” but to be hawkish, said Michael Pearce, senior U.S. economist at Capital Economics.
“They can’t signal any let up. They have to signal a willingness to do whatever it takes on the the hawkish side,” agreed Julia Coronado, president of MacroPolicy Perspectives.
The clearest sign of the hawkish Fed will be in the the central bank’s revised estimates of how high the central bank’s policy interest rate will rise over the next 18 months.
In March, the Fed penciled in a 1.9% rate at the end of the 2022 and a 2.8% rate for the end of 2023
Dent said he thinks the Fed will raise that forecast by 100 basis points to 2.87%. And the Fed will signal the benchmark rate will rise to 3.1% in 2023 “at a minimum,” he added.
That’s restrictive territory, where rates are slowing economic growth.
“The basic story we’re expecting is a steeper path and a higher terminal rate,” Dent said.
Economists at Deutsche Bank think the Fed will eventually raise its benchmark rate to 4% to combat inflation. At the moment, the Fed’s policy rate is in the range of 0.75% – 1%.
Fed officials will meet next Tuesday and Wednesday. The central bankers will release a policy statement and updated economic projections at 2 p.m. Eastern and Fed Chairman Jerome Powell will hold a press conference at 2:30 p.m. Eastern.
Before the CPI reading on Friday, the consensus of economists was that the Fed will raise its benchmark rate by a half-percentage point next week and again at its next meeting on July 28-29. The debate was over what the Fed would do at its September meeting though.
Now, several economists think there is a chance of a 75 basis point move.
Jonathan Millar, acting chief U.S. economist at Barclays Investment Bank, thinks the Fed will surprise the markets with a 50 basis point move next week.
“It does seem they need to do something bold here,” to reinforce their inflation-fighting credibility, Millar said in an interview.
The discussion in September is around another 50 basis point move. Talk of a pause in September floated by Atlanta Fed President Raphael Bostic has been shelved for now.
The Fed’s economic forecast will also garner attention.
In March, the Fed painted a picture of a “soft landing” where the Fed would hike its benchmark interest rate but the unemployment rate would stay low.
It is now dawning on the Fed that it might take a recession to get inflation under control, said Coronado of MacroPolicy Perspectives.
Powell has said he wants to see clear and compelling evidence that inflation is slowing before stopping rate hikes.
But because inflation is a “lagging indicator” demand is likely to slow first, she noted.
Choosing between economic growth and inflation is a choice the Fed didn’t want to make, but Dent of Nomura said it is not a “tough choice.”
“Price stability is everything the Fed has fought for over the past years. It is the bedrock of what they do,” Dent said.
Most economists still don’t forecast a recession.
Dent said he expects a narrow escape from a recession, with the economy only growing at an 0.6% rate over the four quarters in 2023.
“It is not a recession but it is very weak growth. It would not take much to tip the economy into recession at all,” Dent said.
Michelle Meyer, chief economist at Mastercard, said that spending data is still showing consumers spending money, even on “experiences.”
“There are headwinds and a moderation in consumer spending over the rest of the year is very likely a reasonable thing. But by no means are we seeing signs of the consumer capitulating here at all,” Meyer said.
Pearce of Capital Economics agreed there were encouraging signs the economy could avoid a recession.
Job growth has slowed in the hospitality sector and wage growth has slowed. “And that’s what we’re aiming for,” he said.
All three major U.S. stock benchmarks DJIA, -2.73% SPX, -2.91% COMP, -3.52% closed sharply lower Friday, each suffering their biggest weekly loss since January, after the inflation data for May came in much hotter than expected.
See also: Dow slumps nearly 900 points as stocks end sharply lower, book big weekly losses after hotter-than-expected inflation in May