Jerome Powell and Co were right to be cautious about cutting rates. Inflation rose to 3.1% in January from 3% in December, above the 2.9% consensus. Headline PCE fell slightly to 2.8%, just below forecasts, but there’s a real risk things could worsen quickly and affect sentiment around the S&P 500, Nasdaq, and the Dow Jones.
First, major U.S. companies such as Walmart continue to pass on to consumers the costs resulting from last year’s increase in import tariffs. An end to the trade wars could resolve this situation, but the current administration shows no signs of backing down, even after the Supreme Court has ruled on the matter.
Second, tensions in the Middle East, which, according to analysts cited by Reuters, have led to estimated oil production cuts of 7 to 10 million barrels per day, roughly 7% to 10% of global demand, while Qatar has also fully suspended its liquefied natural gas production, pushing up a critical input cost for many goods.
In addition, Qatar and Saudi Arabia are major exporters of urea, ammonia, and diammonium phosphate, key nitrogen and phosphorus fertilizers. Any shortage could drive food prices higher. Qatar also produces more than 30% of the world’s helium, which is widely used in the manufacture of computer chips.
Thus, we are in a highly inflationary environment, meaning the Federal Reserve may adopt a more hawkish stance. The market is already pricing in rate cuts no earlier than the end of this year. For the US Dollar Index, that could be good news, but it is less positive for the bond market and, above all, for the stock market.
And it’s not just the Fed feeling the heat. If the Middle East crisis drags on, other central banks may face a tough choice over whether to return to tighter monetary policy, as the Reserve Bank of Australia did back in February.
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