Hopes that the Federal Reserve can engineer a soft landing for the US economy took a hit on Tuesday when a crucial measure of inflation came in higher than forecast and triggered a sharp sell-off on Wall Street.
The consumer price index increased 0.1 per cent for August, above economists’ expectations for a 0.1 per cent drop. Most worryingly for policymakers, core inflation — which strips out volatile items like energy and food — rose by 0.6 per cent for an annual increase of 6.3 per cent, compared with 5.9 per cent recorded for July.
The figures from the Bureau of Labor Statistics brought an end to a brief respite for Fed officials after July’s reading showed that prices had not risen compared with the prior month.
Wall Street was caught off guard by the hotter-than-expected inflation figures. The S&P 500 closed down 4.3 per cent, the worst performance since June 2020. The Nasdaq Composite, which is stacked with technology companies that are more sensitive to changes in interest rate expectations, ended Tuesday more than 5 per cent lower.
In government debt markets, the yield on the two-year US Treasury, which is more sensitive to interest rate expectations, surged by roughly 0.2 percentage points at 3.75 per cent, having traded at 3.52 per cent before the release of the inflation data.
The odds the Federal Reserve would opt for a full percentage point rate rise in September rose to roughly 30 per cent, according to CME Group, versus 0 per cent at the start of the week. Most economists are forecasting another 0.75 percentage point rate rise, which would lift the fed funds rate to a new target range of 3 per cent to 3.25 per cent.
Steven Blitz, chief US economist at TS Lombard, said Tuesday’s data combined with rising wages and a tight labour market meant the Fed was “not going to produce the soft-landing fairy tale”. He added: “The Fed has better odds of rolling a hard eight than engineering a soft landing.”
“We don’t really see anything in here that would make the Fed want to opt for a slower pace of rate hikes this month,” said Brian Coulton, chief economist at Fitch Ratings.
US president Joe Biden and his economic advisers had also been hoping for a reduction in the headline figure, going so far as to schedule a “celebration” of his recently passed Inflation Reduction Act, a package of healthcare and climate policies.
“Today offers proof that the soul of America is vibrant. The future of America is bright and the promise of America is real,” Biden said at the event on Tuesday. He later noted that petrol prices had dropped over the summer: “We’re making progress.”
Although the event was scheduled to trumpet the passage of the bill, the optics were quickly seized on by Biden’s opponents in the Republican party.
“You can’t make it up: Hours after this terrible inflation report, the White House is hosting an ‘inflation reduction’ celebration,” Mitch McConnell, the Senate minority leader, wrote on Twitter. “Democrats have spent our economy into disaster and now they’re partying while families pay. They could not look more out of touch if they tried.”
The jump in inflation came despite petrol prices tumbling in recent months. Earlier this summer, they topped a record $5 a gallon following a jump in oil prices after Russia’s invasion of Ukraine. The current national average is $3.70, according to the American Automobile Association.
In recent weeks, Fed policymakers have reaffirmed their commitment to bringing inflation under control and warned of the risks associated with allowing price pressures to persist.
Failing to bring down inflation, and allowing expectations of future price increases to spiral, was likely to mean more economic pain later on, chair Jay Powell and vice-chair Lael Brainard said last week.
Policymakers worry the downward trend in petrol prices is unsustainable — especially if energy prices jump later this year. Treasury secretary Janet Yellen warned of that possibility over the weekend, citing concerns about a widespread shortage across Europe as the bloc stops buying oil from Russia.