Fed to weigh more on inflation fight than financial stability after soaring CPI
By Jimmy Zhu
Employees work at a local food bank in Houston, Texas, U.S., February 8, 2022. /CFP

Employees work at a local food bank in Houston, Texas, U.S., February 8, 2022. /CFP

Editor's note: Jimmy Zhu is chief strategist at Fullerton Research. The article reflects the author's opinion, and not necessarily the views of CGTN.

The U.S. inflation data for the month of January released Thursday suggested that the Federal Reserve's ambition of hiking rates wouldn't be moved by the recent rising volatility in financial markets. Raising the interest rates in every meeting in remaining of the year becomes a live event now. 

The consumer price index (CPI) for January rose 7.5 percent from a year ago, according to the U.S. Labor Department, which is far above the earlier estimates and at fastest pace since 1982. After the data released, the U.S. stocks and bonds sold off amid fears on Fed to accelerate tightening pace intensified. The U.S. 10-year government bond broke the key level at 2 percent, while 2-year government bond yield surged 21 basis points (bps), biggest jump since 2009 to 1.579 percent.

It's worth to mention about the U.S. jobs report released on February 4. The non-farm payrolls in January gained 467,000, with average hourly earnings surging as well. Together with the inflation report, the Fed is now likely to hike the benchmark policy rates by 50 bps in the upcoming policy meeting.

Chances for the Fed to raise the rates at every meeting this year shouldn't be ruled out now. There will be seven Federal Open Market Committee (FOMC) meetings left toward the end of the year. If so, market wouldn't be ready for that as Cboe Volatility Index (VIX), a fear-gauge index rose 4 bps to 23.91 after the CPI report, the biggest gain since November last year. The big jump in VIX implied that traders are currently not feeling comfortable on the upcoming rates' path.

However, the impact of monetary policy on the real economy will be very limited in the beginning of the cycle. After the Fed starts raising the interest rates, it won't be able to know immediately whether the policy is effective to ease the inflation pressure or not. Given the inflation is far above the Fed's long-term target at around 2 percent, the central bank has to aggressively raise the rates.

In the past, the Fed could use higher rates to dampen the demand for easing the price pressure, but same strategy alone seems not be able to solve the problem, at least in a short period of time. The current inflation in the U.S. growth is mainly driven by the supply-chain shortage, rising wages due to labor shortage and surging energy prices. None of these issues can be settled by higher rates. 

Supply-chain and labor shortage problems are largely because of the virus forcing many people to stay at home, as well as many ports have shut down. On the other hand, supply constraint is the major factor that keeps pushing the crude price higher, as the output increase has been falling short to meet the rising demand after more economies started opening boarder.

Having said that, the Fed needs to substantially falter the demand in order to ease the inflation if there is no easy to boost the supply. From the currency perspective, U.S. dollar also needs to appreciate sharply to reduce the import cost and contain the commodity prices, which will help to curb the rising inflation pressure.   

To achieve that, the Fed needs to aggressively raise the rates rather than a moderate and gradual approach in the past, and the policy needs to be more hawkish than most of the major central banks in the developed economy. For now, Bank of England has conduced back-to-back rate hike earlier this month, New Zealand and Canadian central banks are expected to raise rates in coming weeks before the FOMC March meeting.

Thus, for U.S. dollar to outperform those major currencies in near term, the Fed may need to raise the rates by 50 bps in March and show its willingness to act aggressively in the remaining of the year.

Given the increasing participating rate from retail traders in the U.S. stock market in past two years, lower stocks prices will also help to contain the consumption demand. The U.S. economy and its financial market need to take some pain in order to balance the mismatch between the supply and demand in 2022.

Market participants expect a hawkish Fed that hasn't been seen in decades, and Fed is also not likely to slow down the pace of rate hikes this time if volatility in financial market to sustain for a long period of time. In other words, do not underestimate Fed's determination to slow down the inflation by whatever it takes this year.

From now to the upcoming FOMC meeting in March, we expect the stock market to stay choppy and U.S. bond yield may further inch higher.

Search Trends