Here’s a key reason why the Fed could remain aggressive on its next rate hike

  • Investors are expecting the Fed to scale back its rate hike in February.
  • Declining inflation fuels an optimistic view of a 25 basis point move, but lodging prices may still appear tacky to policymakers.
  • Market movements suggest the “iceberg of fear” around inflation is shrinking, one analyst said.

Inflation in the US is generally easing, reinforcing expectations that the Federal Reserve will continue to reverse rate hikes, but continued core prices risk policymakers staying at the current pace, analysts say.

After last week’s December inflation report, which showed annual interest rates slowed to 6.5% from 7.1% in November, expectations that the Fed would raise its benchmark rate by 25 basis points on February 1, down from last month’s 50 basis points hike.

But inflation remains above the Fed’s 2% target and policymakers are closely watching prices that exclude energy and food. The core interest rate in December was 0.3% month on month, compared to 0.2% in November. Housing inflation that monitors costs for renters and homeowners rose 0.8%. The Bureau of Labor Statistics said the shelter index was the “dominant factor” driving the core index higher.

“The CPI report was consistent with consensus, but the details paint a picture of continued pressure at the core,” Jefferies economists Aneta Markowska and Thomas Simons wrote in a note this week.

“We think so [the CPI] report keeps a 50 basis point increase on the table for the next FOMC meeting, though it is by no means a high-conviction decision,” the economists said. “Regardless of the size of the next increase, we expect the FOMC to be at 5.1%, the only question is whether we get there in March or May.”

David Russell, vice president of market intelligence at multi-asset trading platform TradeStation, told Insider he also sees potential in the Fed sticking with a half percentage point rate hike at its upcoming meeting.

“There is a risk that the Fed will continue to be aggressive in making sure inflation is really dead and buried,” he said, noting that there is still upward pressure on housing inflation.

Russell said the bigger issue is how much the Fed wants to raise its key rate, which is currently between 4.25% and 4.5%. Recent quarterly Fed projections suggested that central bankers expect this year’s closing interest rate at 5.1%, while investors expect 5.25%.

The Fed, led by Chairman Jerome Powell, is “a long way off” from its inflation target, said Dan Raju, founder and CEO of Tradier, a brokerage and financial-tech services firm. He told Insider he sees a February rate hike of 50 basis points still in play and expects rates to hit 6% this year

“I think the Fed should continue to take an aggressive stance on rate hikes,” he said.

Jamie Dimon, CEO of JPMorgan, also recently said that the key rate could rise to 6%.

Hunger for risk

Even despite further interest rate hikes, equity investors have shown risk appetite, Raju and Russell said.

Raju said his company is seeing a recovery in trading volumes, with stocks already rising in hopes the economy can avoid a hard landing and the Fed has some control over inflation now. Labor market data also points to continued strength in that part of the world’s largest economy.

“Bond yields are falling, the VIX is falling and the dollar is falling, suggesting that the iceberg of fear we’ve seen over the past year is about to shrink,” Russell said. “The market is looking out and they see a scenario of lower inflation… they see us coming to the end of these aggressive rate hikes.”

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