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 After coming into 2016 with an expectation of three or four interest
rate hikes through the year, market participants recently were
viewing the Fed as likely raising interest rates once, if at all, in
light of weak inflation and global volatility.
But Friday's data showed the core consumer price index (CPI), a
measure of underlying U.S. inflation, rose in January by the most in
nearly 4-1/2 years to a 2.2 percent annualized rate. It drew
particular attention as the number was above the Fed's 2.0 percent
target, though it is not the central bank's benchmark inflation
measure.
The uptick in price pressures has already shifted the market's
expectations on the Fed's next move.
"The inflation numbers definitely caught the markets off guard,"
said Joseph Lavorgna, senior economist at Deutsche Bank in New York.
"Last week at this time the market was pricing a 25 percent chance
of a rate hike by year-end and now it’s over 40 percent and that’s
largely because of today’s stronger than expected CPI."
The dollar rose alongside Treasury yields shortly after the data, as
markets saw the higher inflation as nudging the Fed towards
tightening policy. The euro hit its lowest since Feb. 3.
Equity markets have also closely followed expectations on Fed
policy. Lower rates tend to support stocks in general, with
high-paying dividend names like utilities gaining investors' favor.
In an environment of rising rates, banks tend to take the lead.
The expectation of higher interest rates has been cited as one of
the reasons for stocks having fallen as much as 11 percent this
year. The S&P 500 <.SPX> is down 6 percent so far in 2016, and on
track for its third positive week of the year.
The inflation numbers add to recent economic data, including a
stronger job market and consumer spending, that will force the Fed
to seriously reconsider more rate hikes, said Jim Paulsen, chief
investment officer at Wells Capital Management in Minneapolis.
"I think what’s happening is that people are starting to put
tightening back on the table," Paulsen said.
CHOCK-FULL OF FED SPEAKERS
Personal consumption expenditures, the Fed's favorite measure of
price inflation, is out next Friday and could confirm or outweigh
the trend in the CPI reading. Among other market-moving numbers next
week are purchasing managers indexes (PMIs) for the manufacturing
and services sectors and two gauges of consumer confidence.
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Investors and the Fed could address a decline in earnings, now seen
as down 3.7 percent for the S&P 500 in the fourth quarter of last
year, and lower outlooks for 2016 as other reasons to keep rates
lower for longer.
The incoming data gives more weight to next week's scheduled
speeches from many Fed officials, including Vice Chair Stanley
Fischer on Tuesday and Atlanta Fed President Dennis Lockhart on
Thursday as markets look for a change in tone. Two Fed surveys of
business conditions, Richmond and Kansas City, are also out next
week.
"I don't think the Fed can help stocks, they can only hurt them,"
said Wayne Kaufman, chief market analyst at Phoenix Financial
Services in New York.
"If they came out too hawkish that can hurt stocks; too dovish can
help a little but not create sustainable investor demand."
In Fed-watcher parlance, hawks are seen quicker to push for rate
hikes than doves.
In a U-turn late on Wednesday, Fed voting member and hawkish St.
Louis Fed President James Bullard said it would be "unwise" to raise
rates further given U.S. inflation data and global volatility. He
speaks Wednesday in New York, followed by questions from the media.
The Fed's policy-setting committee next meets March 15 and 16 in
Washington, with a statement followed by a news conference with
Chair Janet Yellen.
(Reporting by Rodrigo Campos, additional reporting by Chuck
Mikolajczak and Laila Kearney; Editing by Chizu Nomiyama)
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