Could US inflation figure surge past 8%?
By Andrew Knoll
23:47, 9 March 2022
The US Bureau of Labor Statistics will release its monthly consumer price index report for February on Thursday, with estimates widely projecting an annual headline figure approaching 7.9%.
After hitting a four-decade high of 7.5% in January, such a rise will likely prove supportive of the already-surging dollar, and Federal Reserve chairman, Jerome Powell, has already prepared markets for a quarter-point rate hike at next week’s policy meeting, with several more to follow.
Both Powell’s outlook and that of much of the world hinge, in part, on the conflict in Ukraine, though its timing meant that it had very scarce effects on the February report.
“Market participants expect yet another record-breaking inflation print this Thursday,” wrote Deutsche Bank analysts Jiefu Luo and Justin Weidner in a note obtained by Capital.com on Wednesday. “Inflation fixings imply a 7.85% YoY print, in between consensus level (7.86%) and YoY (7.80%) forecasts. Inflation fixing market is now pricing a protracted period of elevated price pressure.”
They added: “Market participants once again scrambled to source protection against inflation as it quickly became clear that Russian sanctions would put a strain on the global commodity supply chain after Russia commenced the surprise invasion of Ukraine nearly two weeks ago.
“In our view, the confluence of limited liquidity, wrong-footed positioning ahead of the Russia-Ukraine (conflict) and surging commodity prices resulted in artificially low real yield in the long end.”
In the past month, the greenback’s indices (like the DXY, up almost 4% in short order) have leapt and even more recently gold has been soaring toward an all-time high as well. Analysts expect those trends to continue, as US inflation could strengthen the dollar against other currencies while instability and insecurity drive investors to even more secure positions, like gold.
Demand for the dollar has increased along similar lines, with currencies with relatively stable value and dependable governments behind them, such as the US dollar and Japanese Yen, attracting investors seeking safe havens from volatility. Dropping US bond yields have not significantly obstructed the dollar’s rise. Inflation, at least in the near term, could actually buoy the dollar.
Low interest rates galvanised domestic investment, but higher rates on the horizon have chilled domestic investor interest to some degree, as Luo and Weidner note in their description of recent selloffs.
“Earlier this year, the anticipation of significant policy tightening in light of more persistent inflationary pressure prompted sell-offs in both real and nominal yields,” they wrote. “Fund-flow data show investors withdrew $5.7bn from inflation mutual funds leading up to the Russian invasion of Ukraine, an observation mirrored by the inflation ETF share ownership.”
But higher domestic rates tend to spur foreign investment, which along with the demand for dollars amid turbulent times in terms of global markets and regional security should only add to the dollar’s recent skyward lurches.
Despite the risk of over-buying in a brief period of time, as indicated somewhat by their Relative Strength Indices, the dollar as well as gold have continued to take flight. Gold surpassed the $2,000 mark on Wednesday before dropping below as trading closed.
Impact on interest rates
While positions among both financial and news media analysts have varied widely, with some posing questions about a delay in rate hikes and others positing that there might be a remote chance of them doubling from 25 basis points to 50, it appears that Powell’s comments last Wednesday still point to a 25 bps increase. Those plans will likely persist despite the fact that they were formed, for the most part, prior to Russia’s invasion of Ukraine, which has redirected myriad markets and sectors.
“The (conflict) spurred wild moves in the commodity space at a time when the inflation market had just repositioned itself for a Fed ready to tackle inflation and withdraw monetary policy support,” Luo and Weidner wrote.
Powell cited an “extremely tight” US labour market (Luo and Weidner also cited this a driver of rising CPI statistics, especially in key sectors like rents and vehicle prices) as well as inflation many paces ahead of the Fed’s 2% target level.
The Fed, Powell said in remarks to US Congress, will begin cutting its asset holdings once the hikes begin, likely with a quarter-point increase next week. While Powell said that the Fed would use all measures at its disposal in an effort to stem inflation, he also recognised the complexity and uneasiness of the conflict between Russia, Ukraine and their respective allies.
“The near-term effects on the US economy of the invasion of Ukraine, the ongoing (conflict), the sanctions, and of events to come, remain highly uncertain,” Powell said. “Making appropriate monetary policy in this environment requires a recognition that the economy evolves in unexpected ways. We will need to be nimble in responding to incoming data and the evolving outlook.”
On one hand, Russia’s aggression began near the very end of February, and various already rising commodity prices (such as gas, oil and wheat) have only shot up further and more quickly since.
“It is somewhat important to note that this pickup in gas prices was largely not a function of the invasion of Ukraine and the subsequent spikes in global oil prices given that those happened towards the end of the month,” Luo and Weidner wrote. “As such, with average gas prices already above $4.10 a gallon, headline (CPI) will likely make further solid gains in the near-term, under our forecast peaking in the March data at 7.9%.”
Powell extolled the benefits of price stability and pledged to take corrective measures against inflation. He said that between those policy actions and the ongoing resolution of supply-chain issues, he anticipated that inflation would decelerate gradually over the course of the year, a position echoed by the analysts, albeit with a caveat.
“While our models suggest long-term inflation expectations may have risen too much too quickly, the strong momentum behind surging commodity prices renders fading the move prohibitively risky,” Luo and Weidner wrote. “We do, however, expect long-term inflation expectations to normalise to a lower range as the dust settles on geopolitical tension.”