Next week's meeting of the Federal Reserve board is expected to deliver another supersized 75-basis-point (bp) interest rate hike following the reacceleration in underlying inflation.
Just as US markets had started pricing in less aggressive interest-rate increases, data published on Tuesday revealed growth in core CPI of 0.6 per cent, instead of an expected 0.3 per cent, which took its annual rate from 5.9 per cent in July to 6.3 per cent in August.
And while the headline CPI fell back to 8.3 per cent from 8.6 per cent, this compared to an expected drop to 8.1 per cent.
According to NAB's overnight analysis, what is most disconcerting is that the strength in core inflation is very much service-led — categories including vehicle repairs, dental and hospital services, including food, are posting significant gains.
Now, the US finds itself in a situation where prices outside of the Fed's control are holding inflation up, while price pressures for categories of consumption driven by demand are dissipating albeit at varying degrees, leading Westpac to predict a real test of the resolve for the FOMC.
Factoring in the recent rhetoric of the FOMC, Westpac said it “now seems most appropriate to forecast a 75-bp increase at next week's September meeting to be followed by 50-bp hikes at both the November and December meetings”.
That would take the fed funds rate from 2.38 per cent today to 4.13 per cent at year end.
“The scale and persistence of the contributions from shelter and food also points to the FOMC holding to their hawkish resolve through 2023, with rate cuts not beginning until early 2024,” Elliot Clarke, Westpac's senior economist said.
Similarly, VanEck's head of investment and capital markets, Russel Chesler, said: “With US inflation showing strong resilience, the Fed is likely to raise interest rates by 75 basis points at its meeting next week, but it may hike by as much as 100 basis points in an attempt to clamp down even harder on demand.”
“We see several increases for the rest of the year depending on how the economy reacts to the rate rises,” Mr Chesler said.
He pointed to food inflation as particularly worrying, noting that its increase of 11.40 per cent per annum is the highest food inflation since May 1979.
Turning to how the latest data out of the US may impact markets, Mr Chesler said, “equity markets remain vulnerable to further sell-offs”.
“We are still very much in a bear market and there are still numerous downside risks. Although the US had a relatively strong results season with beats outweighing misses, forward guidance has been subdued.
“Many global company balance sheets are going to come under pressure when they refinance debt from historically low levels to the currently increasing interest rate,” Mr Chesler said.
He expects the Australian share market to continue outperforming the US share market, given that local interest rates are likely to remain well below that in the US, as inflation isn't quite as high.
Maja Garaca Djurdjevic
Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.
