Inflation Surges, Consumer Spending Rises: Fed on Course to Increase Rates
Economists were caught off-guard this week as the Federal Reserve’s preferred measure of inflation, the Personal Consumption Expenditures price index, came in hotter than expected. The PCE index rose 0.6% in January, both in core and headline terms, compared to the 0.2% rise in December. The core PCE index, which strips out volatile food and energy prices, rose 4.7%, more than the forecast of 4.3%. The 12-month PCE inflation rate was 5.4%.
The higher-than-expected inflation data has prompted a flurry of debate among central bankers on the need to adjust the pace of interest-rate increases. Presently, the likelihood of a 0.25% rise in the interest rate from 4.75%-5.00% in March is estimated at 73%, and the chance of an additional 0.25% bump in May is calculated at 70.3%. The likelihood of an additional rate increase to between 5.25% and 5.5% in June is slightly more than 50%, according to CME's FedWatch Tool.
Ten-year U.S. Treasury yields jumped 0.08 percentage points, to 3.91% as of mid-morning, while the S&P 500 fell below a key support level. The higher rates are putting pressure on earnings, and investors are now expecting the Fed to increase rates by either a quarter or a half of a percentage point next month.
Along with the higher-than-expected inflation data, consumer spending surged to start 2023. Much of January's inflation surge came from a 2% rise in energy prices, according to the report. The food prices rose by 0.4%. Both goods and services experienced an increase of 0.
Cleveland Fed President Loretta Mester, a nonvoting member of the rate-setting Federal Open Market Committee, has been pushing for more aggressive increases. At the March FOMC meeting, she expressed uncertainty as to whether she would once again push for a 0.5% increase.
The strong inflation data and consumer spending suggest that inflation accelerated to start the new year, putting the Fed in a position where it likely will continue to raise interest rates. In March 2022, the central bank increased benchmark rates by 4.5 percentage points in response to the highest inflation rate in 41 years.
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