Both producer inflation and jobless claims came in stronger than expected in the most recent government reports released on Thursday. The data adds further pressure on the Federal Reserve as it aims to steer the economy toward a soft landing.
With strong data accumulating, current conditions call for the Fed to apply more pressure with several more rate hikes if it wants to prevent the economy from growing too fast.
An economy that grows quickly is not inherently problematic, but elevated inflation, caused by unanchored inflation expectations, could arise if growth continues. The so-called no-landing scenario, in which the economy continues to grow and avoids a contraction, is not a situation that the Fed is willing to bet on.
In the producer prices report, the top-line number for final demand inflation rose by 0.7% in January, marking the biggest increase since June and following an upwardly revised 0.2% decline in December, according to the Labor Department.
At the same time, core producer inflation slightly increased, remaining elevated at 0.5%, up from 0.3% in December.
Additionally, sales margins continue to compress as overall demand slows and inventories remain abundant. Growth of trade services, a proxy for wholesale and retail margins, dropped to 0.2% from 0.8% previously, although it had been running at over 1% for most of 2021 and early last year.
The strong rebound in producer inflation confirms that it is too early to declare victory over inflation, and that the road toward the goal will be bumpy.
At the same time, the labor market has not shown signs of weakening, as weekly jobless claim data last week remained below pre-pandemic levels and were lower than the forecast at 194,000, the Labor Department reported.
One of the few constants that the Fed can use to look for signs of a cooling economy is the housing market. January’s starts fell again, this time at a faster pace of 4.5% compared to 3.4% previously, while building permits, a proxy for future starts, slightly increased by 0.1% after falling by 1% in December, according to the Commerce Department.
The takeaway
The strong economic data should serve as a reminder for the market to remain cautious as the likelihood of further rate hikes increases. This means there is a significant upside risk to our initial prediction that the policy rate’s peak will be at 5.25% by May.
Given that the Federal Reserve pays close attention to changes in economic conditions like those reported Thursday, all possibilities should remain on the table.
