Surging inflation in U.S. raises spectre of Fed rate hikes, rattling global markets

Lawrence Summers

11th April 2024 – (New York) In the wake of a disconcerting U.S. inflation report for March, Lawrence Summers, the former U.S. Treasury Secretary, has cautioned that the Federal Reserve’s next move could be to raise interest rates—a prospect that should be taken with utmost seriousness. Speaking on Bloomberg Television’s “Wall Street Week,” Summers, a Harvard University professor and paid Bloomberg TV contributor, addressed the data released on Wednesday showing that consumer price indexes surpassed economists’ expectations.

The so-called “supercore” services gauge, which excludes volatile items such as food, energy, and shelter costs and is closely watched by Fed policymakers, has shown an uptick. “On the current facts, a rate cut in June would, in my view, be a dangerous and egregious error, reminiscent of the Fed’s 2021 summer misjudgements,” Summers stated. He stressed that the need for rate cuts is presently non-existent.

Despite this tough stance, Summers acknowledged that economic indicators could shift before the Fed’s June meeting, potentially prompting changes in financial markets. However, he noted that while the likelihood still favors a rate cut within the year, “it is not as much as is priced into the markets.”

In what has been a sobering week for investors, the U.S. Consumer Price Index report for March indicated a 3.5% year-on-year increase and a 0.4% rise from February, intensifying anxiety over the timing of anticipated interest rate cuts. The news has prompted a wave of sell-offs in U.S. equities and bonds, rattling confidence and leading to a downturn in major U.S. indices such as the Dow Jones, NASDAQ, and S&P 500, which all closed down.

This unsettling ripple effect reached as far as Hong Kong, where the Hang Seng Index fell sharply, igniting concern over the already fragile state of the local stock and property markets. Highly leveraged property stocks are particularly at risk, with the specter of rising US interest rates threatening any significant recovery in property values and placing continued financial pressure on homeowners in the region.

Financial analysts at Barclays, although not as stringent in their outlook as Summers, have adjusted their forecasts in light of the hot inflation data. Initially anticipating three rate cuts throughout the year, they have now tempered their predictions to a single, modest rate cut in September of 0.25%.

Barclays analysts have suggested that the unexpected inflation figures could shake the Federal Open Market Committee’s (FOMC) belief in a steady return to their 2% inflation target. There’s even talk that the first rate cut could be pushed back to December. What was once a market consensus for three rate cuts has now dwindled to one or two, with a September cut seen as a likely 0.25% adjustment and the probability of a second cut in December dipping to 35%, as per the interest rate futures data from Fedwatch.

Summers has highlighted the gravity of the higher-than-anticipated inflation figures, hinting at a potential shift in the Fed’s strategy towards rate increases. While he considers such a move not highly probable, he advises against investor complacency regarding rate cuts. Summers drew parallels with the Fed’s past errors, particularly the misjudged rate decisions in the summer of 2021.

The March CPI report has shone a spotlight on the intricate challenges facing the Federal Reserve. The all-encompassing inflation rate edged up by 3.5% on a yearly basis, slightly above the forecasted 3.4%, and by 0.4% monthly, surpassing estimates. The core CPI, which strips out food and energy costs, climbed by 3.8% year-on-year and 0.4% month-on-month, marginally exceeding expectations.