As the most critical statement of the week, the US January inflation will come to the fore tomorrow. With consensus forecasts of 0.4% in the headline and 0.5% in the core for January, CPI is expected to rise to 7.3% in the headline and 5.9% in the core on an annual basis. This means that inflation has reached its highest level in the last 40 years. Although partial slackening is observed in some items on a monthly basis, oil and supply bottlenecks are the factors that feed inflation in January in general. Therefore, we expect inflation to continue to rise mainly due to oil and the associated rising costs.
When we turn to the inflation forecasts side after the market intensified rate hike speculations over the FOMC, it is seen that the high trend in expectations continues. Policymakers are increasingly concerned about fixing their inflation expectations, among other signs of ever-increasing price pressures. With the supply shortage continuing in 2022 and rising energy prices amid geopolitical tensions, inflation is likely to increase further in the near term. In fact, at this point, we encounter the following phenomenon: A Fed that will be more proactive against inflation in the short term, and a Fed that will determine its momentum by adding economic growth dynamics to the business in the wider term. For this reason, while the market is actually increasing the expectations this year, it is also trying to gain an immune mechanism to a certain extent. We understand that some opinions are that interest rate increases can go up to 7, but at the moment, it will not be limited to at least 3. Of course, this evaluation is only based on the interest rate increase. Downsizing the balance sheet is an extra part of this business and the real action will come from there.
US CPI inflation and WTI oil price comparison… Source: Bloomberg
Economic growth dynamics are important in this respect: The Fed will lead the tightening frenzy from March (the BOE started raising interest rates in December, it’s a pace-setter for now) and this current tightening comes at a time when the economy is losing momentum. In the first period of the year, we saw a slowdown in business lines due to the direct impact of Covid. Widespread cuts are mostly reflected in sectors with direct impact, which are not susceptible to the epidemic. A mood to reflect the overall economy suggests that activity will improve as the Omicron wave wears off, cases decrease and pandemic restrictions are eased. Economic slowdowns are mostly due to non-pandemic factors, and at this point, the supply bottleneck stands out as the main problem. As supply shortages also mean inflation, it leaves central banks behind in overseeing economic development and prioritizing price stability. In other words, how much can growth risks be taken while tightening?
Economic growth forecasts, a weak start to the year, and the erosion of real incomes by high prices have pushed Central banks into a general trend towards price stability in terms of sustainability. Demand could cool off a bit amid reverse headwinds, including shrinking real incomes, continued supply constraints and the withdrawal of pandemic-related fiscal stimulus. At this stage, at the point of tightening the monetary policy, it will be important how far the central banks will go. This brings us to the following point: The Fed controls short-term expectations with a rapid tightening, reduces the spillover effect of inflation, and waits for external factors to improve. The rapid pullback of expansion continues until the liquidity and support composition returns to normal, while the Fed watches whether it harms growth and employment. The more inflation deviates from the target, the faster the Fed will be expected to act.
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