Fed gets more room to pause rate hikes after drops in producer prices, retail sales

US producer prices and retail sales both declined in February, giving Federal Reserve officials more room to potentially pause interest-rate hikes as they weigh the impact of a banking crisis against inflation risks.

The producer price index, a measure of wholesale costs, unexpectedly fell 0.1 per cent from the prior month, suggesting inflation pressures are easing in parts of the economy, Labor Department data showed on Wednesday (Mar 15).

A separate Commerce Department report showed retail sales declined 0.4 per cent from the previous month following a surge in January, a sign that consumers are becoming more discerning with spending amid rising interest rates and persistent inflation.

Fed Chair Jerome Powell had flagged the PPI as a key indicator ahead of next week’s gathering of policymakers. Powell had floated the possibility of speeding up the pace of rate hikes before the unravelling of Silicon Valley Bank last week triggered worldwide concerns about the stability of the banking sector.

Credit Suisse Group ignited a global market rout on Wednesday after its biggest shareholder ruled out investing more in the banking giant, and oil slumped to a 15-month low.

Swaps traders now put roughly 50-50 odds on either a pause next week or a quarter-point increase.

“US data shows soft producer price inflation and retail sales, which gives the market further excuse to push in the direction of a no change Fed decision next week,” James Knightley, chief international economist at ING, said in a note. “Coupled with an inevitable tightening of lending conditions given recent events, the need for extra hikes is doubtful.”

The Fed began aggressively raising interest rates a year ago, bringing the target on its benchmark rate to a range of 4.5 per cent to 4.75 per cent.

Eight out of 13 retail categories dropped last month, including declines in furniture, cars and clothing. Sales at gasoline stations also fell, likely reflecting lower prices in the month.

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US producer prices unexpectedly fall in February

Sales at restaurants and bars – the only service-sector category in the report – fell 2.2 per cent in February, the most in over a year.

While a resilient labour market has allowed many Americans to keep spending, others are relying on credits cards and having a harder time making ends meet.

That said, it can be difficult to draw concrete conclusions from the retail sales report as the data aren’t adjusted for inflation and mostly only capture spending on goods. A separate report on February household demand that includes price-adjusted goods and services spending is due later this month.

“American consumers still appear to be spending at a rate that will make the Fed uncomfortable with the inflation outlook, warranting a further tap on the brakes,” Sal Guatieri, an economist at BMO Capital Markets, said in a note. “Of course, the Fed now has bigger fish to fry, making next week’s decision less dependent on the data and more reliant on how the banking turmoil evolves.”

The PPI for final demand fell from the prior month and increased 4.6 per cent from a year earlier, the slowest pace in almost two years. Excluding the volatile food and energy components, the so-called core PPI was unchanged from a month earlier.

The decline in the PPI reflected decreases in both goods and services. That said, more than 80 per cent of the retreat in merchandise can be attributed to a drop in the cost of eggs, the agency said. Services prices were restrained by machinery and vehicle wholesaling.

The closely watched consumer price index, released Tuesday, showed broad-based and persistent inflation, buoyed by a strong labour market. The PPI has slowed significantly on a year-over-year basis amid improving supply chains and declines in many commodities.

But in just a week, the focus has moved from economic data to markets – even more so after Credit Suisse shares dropped on Wednesday. Bob Michele, chief investment officer of JPMorgan Asset Management, said Fed officials should pause their hiking campaign. 

“With Credit Suisse on the table, they will pause – I think they should pause,” Michele said on Bloomberg Television. “Inflation is now very backward looking, you’re seeing cracks form, you’re seeing the liquidity and perhaps solvency of the banking system come under a lot of pressure. That’s going to cause a lot of businesses and consumers to pull back.” BLOOMBERG