Surging US Inflation Increases Recession Risk

A string of inflation reports in recent days indicate that U.S. inflation showed no clear sign of easing, which is likely to prompt the Federal Reserve to consider a bigger interest rate hike at its meeting this week.

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As investors and economists bet on a 75-basis-point rate hike amid surprises in inflation data and expect aggressive monetary tightening going forward, fears of an impending U.S. recession are growing.

HOW LIKELY IS 75-BPS HIKE?

"A 75-basis-point hike seems very likely now," Desmond Lachman, senior fellow at the American Enterprise Institute and a former official at the International Monetary Fund, said.

"The reason that the Fed is thinking seriously now of 75 basis points is that the inflation number last week was higher than they expected. The Fed is determined to regain control over inflation," Lachman said.

The U.S. Labor Department reported Friday that consumer price index (CPI) skyrocketed 8.6 percent in May from a year earlier, marking the third straight month of inflation over 8 percent and hitting a new four-decade high. The figures, which exceeded consensus estimates, dashed hopes that inflation had peaked.

Both British multinational bank Barclays and New York-based investment bank Jefferies changed their forecasts Friday to include a 75-basis-point hike for the Federal Open Market Committee (FOMC)'s June 14-15 meeting, the CNBC reported.

On Monday, a survey by the Federal Reserve Bank of New York showed that the median one-year-ahead inflation expectation increased to 6.6 percent in May, up from 6.3 percent in April. Household spending expectations over the next year, meanwhile, rose by 1.0 percentage point to reach 9.0 percent, a new series high.

On Tuesday, the U.S. Labor Department reported that producer price index (PPI) surged 10.8 percent year on year in May, the latest sign of mounting inflation pressure.

"Prior to Friday, June 10, we shared the universal consensus that the FOMC would hike rates by 50 bps at its June 15 policy meeting. But the higher-than-expected inflation print for May now has us looking for a 75 bps rate hike," Jay Bryson and Michael Pugliese, economists at Wells Fargo Securities said in an analysis Tuesday.

"This expectation was reinforced by press reports on June 13 that seem designed to re-calibrate market expectations regarding the potential magnitude of the rate hike," Bryson and Pugliese said. The Wall Street Journal reported Monday afternoon that the Fed is "likely to consider" a 0.75-percentage-point rate rise this week.

Later on Monday, economists at JP Morgan and Goldman Sachs said in client notes that they expect the Fed to raise its policy rate by 75 basis points on Wednesday, according to a MarketWatch report.

Bryson and Pugliese noted that they also look for a meaningful upward shift in the so-called "dot plot," a chart that records each Fed official's projection for interest rate. They expect the median dot to shift up to 3.375 percent at the end of this year.

RECESSION FEARS GROW

In mid-March, the Fed raised its benchmark interest rate by a quarter percentage point to a range of 0.25 percent to 0.5 percent from near zero amid persistently high inflation, exiting from the ultra-loose monetary policy enacted at the start of the COVID-19 pandemic.

In early May, the Fed raised rate by a half percentage point, marking the sharpest rate hike since 2000, and signaled it would keep hiking at that pace at the next couple of meetings. A quarter-percentage-point hike is the Fed's more common pace.

A 75-basis-point rate hike, something the Fed hasn't done since 1994, would mark a major shift from Fed Chair Jerome Powell' remarks in early May that 50-basis-point interest rate increases should be "on the table" at the next couple of meetings. Fed officials began their pre-meeting quiet period on June 4.

According to the Chicago Mercantile Exchange Group's FedWatch tool, the probability of a 75-basis-point rate hike at the Fed's meeting this week was over 95 percent on Tuesday, compared with roughly 13.6 percent a month ago.

"The market has reacted badly to the news with the stock market losing more ground and bond yields rising sharply," Lachman told Xinhua. "If the Fed actually does go 75 points tomorrow, I do not expect that the market will react much because 75 points is what they are now expecting the Fed to do."

U.S. stocks on Monday entered a bear market because the S&P 500 closed more than 21 percent below its all-time record close reached as recently as last January, S&P Global Dow Jones Indices senior index analyst Howard Silverblatt wrote, as quoted by CNBC.

Investors are increasingly concerned that the central bank's faster monetary tightening to tame the worse inflation in four decades will plunge the U.S. economy into a recession.

"With inflation now at a new 41-year high, recession fears instantly grew," Kevin Matras, executive vice president at Chicago-based Zacks Investment Research, said in a note Monday.

Former U.S. Treasury Secretary Lawrence Summers, who warned about inflationary risks back in February 2021, recently predicted that a recession will likely hit the United States within the next two years.

"Recession risks are high - uncomfortably high - and rising," Mark Zandi, chief economist at Moody's Analytics, said in a recent note. "For the economy to navigate through without suffering a downturn, we need some very deft policymaking from the Fed and a bit of luck."

Lachman said that since the start of the year, declining equity and bond market prices have resulted in the evaporation of around US$12 trillion in household wealth. Any further loss of such wealth "must heighten the risk that we are in for a hard economic landing by early next year," he pointed out.