‘The Fed Should Hike Next Week’

The Fed “could” and “should” hike rates next week.

That’s according to BofA’s Michael Hartnett, who delivered a characteristically colorful take on America’s rather vexing policy conundrum in the latest edition of the bank’s popular weekly “Flow Show” series.

Hartnett focused mainly on what he described as a “red-hot” labor market, but tightness there is inextricably bound up with the inflation discussion, given that the combination of surging prices and worker scarcity is a recipe for a wage-price spiral.

US inflation data out Friday showed prices accelerated at the swiftest annual rate in 40 years last month. The gains were broad-based.

“CPI has averaged 0.6% MoM gains in 2021. If that continues [over] the next six months, US headline CPI will be 7.4% in April,” Hartnett said, adding that even if the monthly pace falls to 0.3%, the headline gauge will still be well above 5% midway through Q2 (figure below, from BofA).

The Fed won’t heed Hartnett’s “advice.” (The scare quotes are there to denote that he’s not actually advising anyone. He writes in a colloquial, reader-friendly cadence.)

But even though a surprise hike while the taper is ongoing is out of the question, the market may begin to price the risk of a 50bps hike in March aimed at cooling off the labor market, Hartnett went on to suggest.

The figure (below) is meant to back up that contention.

The Fed “has always hiked once LMCI has exceeded 0,” Hartnett remarked.

This goes without saying, but an “out of the blue” Fed hike that isn’t priced in by anyone, anywhere, would do more to erode the market’s faith in US monetary policy than a Fed that stays behind the curve at the risk of losing any and all inflation-fighting credibility.

It comes back to the post-financial crisis monetary policy mode. Markets expect transparency and predictably. When markets feel cut out of the loop, the front-end reacts violently and the back-end rallies in protest.

For evidence of that, just consult October’s front-end fireworks and/or the curve’s recent “comments” on the likelihood of a policy error should the Fed tighten into a burgeoning slowdown.

Still, every month that inflation remains elevated is another body blow to the Fed’s reputation. It is, as one economist told Bloomberg after Friday’s data, “a very difficult spot” for Jerome Powell.

“Yes the old adage is ‘buy the first hike, sell the penultimate hike,’ yes real rates are still negative, yes Jerome doesn’t want to bankrupt Joe and Janet, yes the ECB is still on a different planet as usual, but inflation is extremely high and inflation causes recessions,” Hartnett went on to say.