Consumer Price Index (CPI) inflation in February was consistently high at 6% overall, with Core inflation of 5.5%, excluding volatile food and energy costs into account. While overall annual CPI is down from 6.3% in January, Core CPI remains the same. The Fed follows Core CPI to make rate policy. Monthly Overall CPI decreased by 10 basis points to 0.4%, while Core CPI increased by 10 basis points to 0.5%, potentially exerting upward pressure on the Fed to raise rates again, particularly if the banking crisis persists in its calming trend.
Bond king Jeff Gundlach believes the Fed has to do a 25 basis point hike to preserve its inflation-fighting credibility and predicts they’d pause after that. Goldman Sachs has revised their forecast for a rate hike, stating that 25 basis point increases would occur in the next three Fed meetings instead.
It is ironic that the Fed’s rate hikes are contributing to the current challenges faced by banks. When the Fed raises rates rapidly following a prolonged period of low rates, banks end up paying more on deposits than they earn on loans. While this is a simplified explanation of the current banking issues, it remains a significant problem. Nevertheless, the Fed must continue to combat inflation. Before the SBV-triggered bank crisis, the Fed was planning to raise overnight bank-to-bank lending rates by 50 basis points. However, after February’s persistent inflation and the easing banking crisis, it is more probable that the Fed will increase rates by only 25 basis points.
Mortgage rates declined from approximately 7% to around 6.5% due to the surge in mortgage bonds during the banking crisis. These bonds provide a secure investment option during market turmoil, causing rates to fall as bond prices increase during a buying rally. However, inflation data may push mortgage rates up, as inflation erodes future cash flows for bond investors. Bond investors will be cautious until the bank crisis relief signals become clearer, so hopefully, the rate drops we got during the bank crisis peak don’t disappear.