Over the last few months, we've had a stream of inflation data that consistently comes in above expectations. The producer price index report for January continued this trend as it rose 1% on a monthly basis and 9.7% on an annual basis. Both figures were significantly above analysts' expectations.
Of course, this news comes just as the Federal Reserve is about to embark on a rate hiking schedule that has increased in its scale and speed due to such elevated inflation readings. The wholesale price index is also concerning as it's showing that inflation expectations on the supply side are becoming unanchored even while inflation expectations on the consumer side remain muted.
The PPI data caused stocks to give up a chunk of pre-market gains which came about due to reports that Russia had relocated some troops away from the border. Treasury yields also moved higher with the 10-year above 2% and the 2-year at 1.58%, marking their highest levels since 2019.
PPI data measures inflation on the supply side and is considered a leading indicator of consumer inflation. Just like there are concerns of a wage-price spiral when the labor market is tight, there are concerns that companies could start more aggressively hiking prices if their inflation expectations get embedded as well. So far, stock market investors have rewarded companies who have been able to raise prices with no drop in demand.
Even the services sector is starting to see some inflationary pressures as this rose 0.7% compared to 1.3% for the goods sector. Energy prices rose 2.5%, while food prices increased 1.6%.
After the report, Fed fund futures remained unchanged, although they have sharply risen in recent weeks as the market now forecasts 7 hikes with more than a 50% chance of a 50 basis point hike in March. There are even rumors of a 75 basis point hike, multiple 50 basis point hikes, and intra-meeting hikes in addition to selling assets from the balance sheet as tools to fight inflation.
The Fed's challenge is to fight inflation without forcing the economy into a recession. What's ominous is that the Fed has never failed to bring down inflation without inducing a recession. The case for this time being an exception is that inflationary pressures ebb due to a shift to services consumption from goods consumption and relief in supply chain issues and transportation bottlenecks.