Will the Fed Pursue Aggressive Tightening?

The stock market will be focusing on the pace of Fed tightening ahead, as well as the Russian/Ukrainian situation.  The high January CPI raised the risk of aggressive Fed tightening, including the possibility of a 50 BP hike at the March meeting according to some Street economists.  At this point, however, a CNBC news report suggests the high CPI did not prompt a majority of FOMC members to change their expectation of a measured approach to tightening, that is in 25 BP increments.  They would be more concerned if inflation continues to be high in H222.  This week's release of the January FOMC Minutes could highlight this view.

In any case, there is still more evidence to see before the March 15-16 FOMC Meeting, which could influence market expectations if not Fed officials.  It includes the February Employment Report (March 4) and February CPI (March 10).  Strong prints will raise the risk of a 50 BP hike, while softer ones could hold down expectations of a rate hike to 25 BPs. 

Another high print for the February CPI cannot be ruled out.  The January CPI showed a broad swath of components with large m/m increases.  Higher wages and oil prices were likely the main culprits -- and their pass-through is unlikely to disappear soon.  Nevertheless, a couple of temporary factors may have exacerbated the January CPI's move up:  /1/ start-of-year hikes (which could persist to some extent in February because of bi-monthly sampling, but probably should show up to a smaller extent than in January) and /2/ a larger boost from the new seasonal factors (which will be balanced by smaller boosts in other months).  So, there could be some easing in February inflation.  Historically, the February Core CPI slowed in the two years ahead of the pandemic.  In addition, the January report contained evidence that price hikes stemming from supply disruptions may be peaking.  New Motor Vehicle Prices were flat and Used Car Prices slowed.

The large +467k m/m increase in January Nonfarm Payrolls also appear to have resulted in part from revised seasonals.  Seasonals added about 230k more to the m/m change than they did in January 2020.  There will be "payback" in the remaining months of 2022.  And, a smaller jobs gain in February can't be ruled out.

Regardless of the technical issue regarding seasonal adjustment, the economy still has to slow enough to generate labor market slack.  The sooner and larger this slack is created, the shorter will be the period of high inflation.   Given its dual mandate of maximum employment and low inflation, however, the Fed may be reluctant to aim for such a strong attack against inflation.  If it doesn't and the labor market remains tight and inflation high, the Treasury and stock markets will likely take on the job of braking the economy. 

This week's US economic data are not expected to give the Fed solace.  Consensus looks for the January PPI to speed up to +0.6% m/m from +0.2% for Total and to remain high at 0.5% for Core.  Consensus also sees January Retail Sales rebounding 1.6% m/m after -1.9% for Total and +0.7% after -2.3% for Ex Auto.  A large upward revision to December would seem to be a good possibility, as well. The Unemployment Claims data also will provide clues whether labor market slack is developing.  After giving mixed evidence in January (Initial higher, Continuing lower m/m), they suggest a modest tightening in labor market conditions has resumed.  The latest week's Initial and Continuing Claims are below their January averages (255k and 1.634 Mn, respectively).