Dusseldorf, Frankfurt, New York Worse than expected and still better than feared – this is how the eagerly awaited latest inflation data from the USA can be summarized. In March, consumer prices in the world’s largest currency area rose by 8.5 percent compared to the same month last year. This was announced by the Department of Labor on Tuesday in Washington.
Energy prices rose particularly drastically in March, climbing by 32 percent. Groceries cost 8.8 percent more. The cost of housing rose by five percent. Core inflation, which excludes volatile energy and food developments, is 6.5 percent, also the highest level in 40 years.
However, the market had expected even worse core inflation, with economists estimating 6.6 percent. Allianz’s chief economic advisor, Mohamed El-Erian, sees the figures as “a great relief for the markets”, as he wrote on Twitter. Above all against the background that the price increases in the past few months have always been significantly higher than expected.
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Commerzbank economist Bernd Weidensteiner sees a chance that inflation will have peaked in March. From his point of view, whether this is actually the case depends above all on the further price development of oil and petrol: “If the oil price remains at the current level of around 100 dollars a barrel and does not rise again, the inflation peak is probably behind us .”
Investors on the bond markets initially reacted to the new data with relief: prices rose and yields fell in return. However, inflation and the Fed’s interest rate turnaround have already weighed heavily on the bond markets: since the beginning of the year, US government bond prices have fallen by almost eight percent. According to the information service Bloomberg, investors are thus heading for the largest price loss since 1973, the year of the first oil price crisis.
Yields on ten-year US government bonds have risen from 1.5 to 2.8 percent since the beginning of the year, while yields on two-year bonds have soared from 0.7 to up to 2.5 percent. Yields fell about 0.1 percentage point from Monday’s daily highs following the latest inflation figures, which corresponds to a significant daily movement for US bonds.
This also pushed down the yields on German bonds somewhat. At just under 0.8 percent for ten years, German government bonds are still yielding their highest level for more than seven years. The situation on the stock market was similar. European indices pared losses on Tuesday afternoon, while Wall Street rallied higher at the open.
Despite the hope for at least somewhat more moderate inflation, Commerzbank expert Weidensteiner sees no all-clear for the US Federal Reserve. Even in a favorable scenario, inflation would remain exceptionally high for some time. Therefore, there is still a risk that a wage-price spiral will start, in which both factors reinforce each other. The labor market in the USA is very robust, with an unemployment rate of 3.6 percent, there is almost full employment.
The Fed must therefore get inflation under control quickly and keep long-term inflation expectations stable, demands Weidensteiner. The next few months will show whether the more determined action announced by the US Federal Reserve is sufficient. “US monetary policy is thus in a crucial phase.”
Amplifier pressure for the Fed
Policymakers have to strike a difficult balance between fighting inflation and the risk of a recession triggered by a too-quick and too-severe monetary policy turn. Fed Chair Jerome Powell has already made it clear that containing inflation is the top priority. Powell has also signaled that he is open to a so-called double rate hike.
As a rule, monetary politicians raise interest rates by a quarter of a percentage point. However, the minutes of the most recent Fed meeting show that the central bankers had already planned an increase of 0.5 percentage points in March, but then decided against it due to the uncertainty caused by the Ukraine war and left it at 25 basis points.
After many years of an extremely loose monetary policy, the Fed has thus initiated the turnaround in interest rates and increased its key rate to the new level of 0.25 to 0.50 percent. Now a sharp hike in May is becoming more and more likely. Charles Evans of the Chicago regional Fed said Monday that a 0.5 percentage point hike is “obviously worth considering, if not highly likely.”
According to James Bullard, head of the St. Louis Federal Reserve District, the Fed is also lagging behind inflation. In his view, even in a benevolent scenario, the key interest rate would have to be 3.5 percent in order to be able to counteract the extraordinarily high inflation effectively.
Not only does the Fed want to raise interest rates sharply, it also wants to shrink its balance sheet, which swelled to almost $9 trillion during the pandemic. The central bank is considering letting bonds worth up to $95 billion a month expire and not reinvest them. This step is to be finally decided in May. The reduction would thus be twice as fast as the previous one from 2017. At that time, however, the inflation rate was also significantly lower.
There are political consequences
Inflation could also have serious political ramifications in the US: November’s midterm elections could see Democratic President Joe Biden lose his Senate majority. The rising prices could be decisive, as the latest surveys show. In a CBS survey, nearly three-quarters of respondents cited inflation as a government priority. And 69 percent said that Biden is not approaching the issue with enough determination.
The Republicans are mainly exploiting the rising gas prices for their election campaign against Biden. At gas stations all over the country there are trailers with large signs: “Gas too high? Register Republican!” – in German: Gasoline too expensive? Sign up as a Republican!
Overall, nervousness remains high on the markets despite the short-term relaxation. Major investors’ concerns about stagflation are as strong as they were last during the 2008 financial crisis, according to the monthly Bank of America (BofA) survey of international fund managers for April. The nearly 300 investors surveyed now expect the US Federal Reserve to raise interest rates seven times in 2022 alone.
A larger majority than ever before also expects weaker growth in the global economy. A net 71 percent have this fear. That means there are 71 percent more investors who expect the global economy to cool down than the other way around. Those surveyed named a global recession as the greatest risk for the development of the capital markets, even before the change in monetary policy and inflation
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