Can this cycle end?

This week there were economic reports showing that CPI inflation is not fading away. The markets were convinced that inflation reports would be benign, and the trend toward the Fed’s target of 2% for the fed funds rate would allow the Fed to back off. Incredibly there were even some reports out of highly regarded research shops like Goldman Sachs that postulated the soft landing scenario again, this time with no recession and inflation receding with very little new action by the Fed.

All of that ended this week as US CPI came out on Tuesday, hotter than expected. And on Thursday some Fed officials stated rate hikes will have to be continued for much longer. The 25 basis points hikes that the market was convinced would be the maximum from now on have been discarded and the talk is now back to several more hikes with even 50 basis points a possibility.

The Thursday news that rocked the markets was the producer price index (PPI) which rose month-over-month at 0.7% or 8.4% annualized. The year-over-year number was 6%. Earlier this week the CPI came in at 6% and disappointed traders who had become convinced that the Fed was just about done with its rate hiking cycle.

Here are comments that the market did not like:

Cleveland Fed President Loretta Mester said:

James Bullard, in the same role in St. Louis, was even more brutal in his comments about the need to fight inflation:

These comments were widely reported, and it will be difficult for the markets, both bonds and stocks, to shrug off this sentiment. The reality of further rate hikes for the remainder of 2023, and a policy rate of 5.375%, almost a full percentage point higher than current rates, will be a giant headwind for the bullish speculators who had been driving the markets higher in January.

In Canada the central bankers have little choice but to follow the US lead on policy. The Canadian currency market is worried that the Bank of Canada might try to go it alone, and not follow the Fed to tighter monetary policy and higher interest rates. The Canadian dollar dropped by about ½ of one percent on Thursday as traders contemplated those possibilities. If Canada does try to go it alone, and the Canadian Loonie drops into the 65 to 70 cent range, inflation in Canada will be pushed even higher, defeating the BOC’s efforts to be independent.

Of course, central bankers are worried about the effect of higher rates on the Canadian housing market. Already prices in some cities are down more than 20 percent and average prices are down 15 percent. This puts some heavily indebtedly buyers of houses in trouble.

But the rate hiking cycle is not yet over.

Hilliard MacBeth

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