Rate Hikes Are Coming...
Submitted by QTR's Fringe Finance
What a week for macroeconomic data. We got two horrific datapoints this week that, when combined with some key comments from days ago, seem to be pushing the Fed closer to rate hikes than they’ve been in a long while.
The case for rate hikes is no longer some fringe tail risk like it felt it was a year ago as inflation numbers (though still high) appeared to be coming down.
For most of last year, markets were operating under a very clean narrative that inflation would continue cooling, growth would gradually slow, and the Federal Reserve would eventually be in position to cut rates further. That framework is starting to crack.
Regardless of whether investors were focused on a potentially more dovish policy direction under figures like Kevin Warsh or Stephen Miran, the Fed ultimately cannot sidestep hard inflation data. If price pressures are clearly reaccelerating, policymakers risk losing massive credibility if they continue signaling easing while inflation moves in the opposite direction.
The market is being forced to confront that reality in real time. And this chart from Charlie Bilello yesterday shows exactly what that reality looks like: inflation got away from the Fed in 2020, and we haven’t been anywhere near close to returning it toward the baseline trend we have tried to revert to. In fact, the chart shows the delta between the 2% baseline target and current inflation as widening.
That pressure intensified today after a major upside surprise in wholesale inflation.
The latest producer price index report showed wholesale prices rose 1.4% in April, nearly triple expectations of 0.5% and well above March’s upwardly revised 0.7% increase. On an annual basis, producer prices climbed 6%, marking the biggest increase since December 2022.
This matters because producer prices often serve as an early warning signal for future consumer inflation. Rising input costs eventually work their way through supply chains and show up in prices paid by households. The bigger issue is that this increasingly looks like something broader than a temporary energy spike. Pipeline inflation is building again at a time when the Fed had been hoping for sustained disinflation.
Meanwhile as CNBC noted earlier in the week that the CPI was also still coming in hotter than expected — which was already hot at 3.8%. Don’t lose sight of the fact that the Fed’s target is 2%, so this is nearly double what the Central Bank is gunning for:
The consumer price index rose at a seasonally adjusted 0.6% for the month, putting the one-year pace at 3.8%, the Bureau of Labor Statistics reported Tuesday. The monthly rate was as forecast, but the annual rate was 0.1 percentage point above the Dow Jones consensus.
As CNBC noted, following the hotter consumer inflation report earlier this week, traders sharply reduced expectations for rate cuts and began pricing in the possibility that the Fed’s next move could actually be higher. According to CME FedWatch data cited by CNBC, markets were pricing roughly a 37% probability of a rate hike before year end.
That is a dramatic reversal from the dominant consensus just weeks ago, when the conversation centered almost entirely around when cuts would begin.
What makes this shift even more significant is that Fed officials themselves are no longer trying to shut down the possibility of tighter policy. Austan Goolsbee said last week in an interview with Bloomberg that all options remain on the table and explicitly pushed back on the idea that cuts are the only possible path forward. He said he does not see how anyone can look at current conditions and assume the only conceivable outcome is lower rates.
He also made clear that his concerns extend beyond energy and include broader inflation pressures that could prove more persistent. That is an important signal because central bankers tend to avoid discussing hikes unless they believe the risk is becoming materially more realistic.
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The broader takeaway is that markets may still be underestimating how quickly the macro narrative can shift. The dominant trade had been built around lower inflation, lower rates, and a soft landing. That assumption now faces growing pressure from rising producer prices, elevated inflation expectations, persistent energy shocks, and increasingly hawkish market pricing. If inflation remains hot for another month or two, the conversation may move beyond higher for longer and toward the possibility that the next move from the Federal Reserve is another hike.
That would represent a major regime change for markets that have spent months positioning for the exact opposite outcome.
I’ve been saying for months that the Fed is stuck between a rock and a hard place, and now that reality is getting harder to spin away with carefully worded press conferences and endless “data dependent” talking points. If they raise rates into this inflation reacceleration, they risk detonating the parts of the economy that have only survived because money was essentially free for years. The most speculative and overleveraged corners get hit first. Bitcoin and broader crypto would likely get smoked, subprime auto lending’s implosion accelerates, and the ever growing Private Credit shit officially hits the fan.
But if the Fed backs off because markets throw a tantrum and stocks forget how to go up for three consecutive weeks, they’ll be right back to printing money and flooding the system with liquidity to save everyone from the consequences of their own leverage. And what does more printing solve when inflation is already running hot? Absolutely nothing, except ensuring you get another inflation wave later that’s even harder to contain. That’s the trap. Raise rates and break the economy. Print money and make inflation worse.
Years of kicking the can down the road have left the Fed with two terrible choices, and now the bill is showing up right on schedule. Turns out “we can have permanently elevated asset prices, endless stimulus, and no consequences” was not actually a serious economic strategy. Who would have thought?
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