No one will find encouragement in Tuesday's update on wholesale prices, which posted a troubling 1.1% rise last month. So far, however, the Fed funds futures market is still inclined to see another rate cut when the FOMC meets again on April 29 and 30.
Perhaps, the time has passed for swashbuckling 75-basis-point slashes in the Fed funds. The hour is late when it comes to nipping pricing momentum in the bud. Yesterday's producer price report is just one more clue that it's time for the central bank to pay more attention to pricing pressures bubbling. This idea is all the more compelling when you consider that while the Fed can't do much more at this point to juice the economy via broad changes in interest rates, but it can still act as the defender of last resort when it comes to inflation.
Today, we learned that consumer price inflation rose 0.3% as expected (core CPI rose 0.2%), via the government's update for March CPI, providing the market slight relief it wasn't worse coming off yesterday's PPI numbers. Meantime, it's clear that PPI inflation is still a threat. The 1.1% jump in PPI last month is the highest so far in 2008, and in the upper range for monthly numbers over the last few years. On an annual basis, PPI is now advancing by 6.9%. That's down slightly from the 7.7% peak set in January, but it's still too high to ignore.
Yes, both food and energy costs are the main sources of inflation in yesterday's PPI. The Fed likes to ignore such "noise." That may have worked in the past, but for the moment the idea that core inflation is a better measure of future inflation continues to look outdated. The political realities are such that at some point one of two things has to happen: food and energy costs stop rising or go down; or the Fed attacks the problem with a more hawkish monetary policy. The challenge is deciding when to act, if at all. Sitting around for another six months to get better data no longer looks like a viable option.
In the context of the next few weeks, however, there's still hope that commodity prices will fall, which will give the central bank cover for at least one more crowd-pleasing FOMC announcement. The May '08 Fed funds futures contract is priced in anticipation that a 25-basis-point cut is probably coming. But there's some anxiety hanging over the market. Until and unless the economic slump deteriorates dramatically in the coming weeks, the Fed may feel compelled to stand pat later this month.
In any case, it seems prudent to consider the prospect that FOMC meetings may come and go without a rate cut announcement from here on out. The risk is that the markets haven't yet fully priced in that scenario.