Tuesday's inflation reading wasn't what anyone was hoping for.
The consumer price index rose 8.3% in August year-over-year, down slightly from July but more than the 8.1% economists had expected. If you take out the price of food and energy, core prices rose 0.6% from July to August — double what economists had forecast.
The surprisingly ugly CPI report undercut investors' confidence and sent markets tumbling. The Dow fell more than 1,200 points, or 4%, while the S&P 500 and Nasdaq plummeted 4.3% and 5.2%.
It was Wall Street's worst day since June 2020.
And, as the last major economic data release before next week's Federal Reserve policy meeting, Tuesday's report all but guaranteed the central bank will announce another meaty interest rate hike.
Let's step back: All of this is bad news for consumers, who are being hit with a quadruple-whammy of financial pain — inflation is eating into everyone's wallet; higher interest rates are making it harder to borrow money; wages are mostly flat; and 401(k)s are a shambles as the market sinks.
(Oh, and in case you missed last night's newsletter, there's a looming freight rail worker strike at the end of this week that could further strain supply chains and push prices up.)
The Fed's been raising rates for the past six months, and it's still far from its inflation target of around 2%. At this point, is it time to acknowledge that the pricing problem simply too big and gnarly for the central bank to fix on its own?
The short, not-super-satisfying answer: Probably.
The big-picture problem here is that no one — no matter what they claim in their Twitter hot takes or in their endless commentaries on TV — actually knows what to do here, in this wacky economy that's been throttled by unprecedented shocks.
Like, raising interest rates should slow demand, sure. But ending the war in Ukraine would be a bigger help (on so many levels). The Fed can't do that. Untangling supply chains would also be nice. (Also not the Fed's jurisdiction.) Eliminating Covid and stopping climate change couldn't hurt. (I wish Jay Powell could swoop in, snap his fingers to make that happen, but, sadly, he cannot.)
"The economy is in a very unusual place, and some of this may be the result of a very unusual pandemic," says David Wessel, a senior fellow in Economic Studies at Brookings and director of the Hutchins Center on Fiscal and Monetary Policy.
But this isn't even close to the crisis that the Fed faced in 2007 and 2008, when the financial system fell apart and the Great Recession took hold.
"We have a very strong labor market, strong consumer demand and high inflation," Wessel says. "The Fed has to raise interest rates. And the fact is that it doesn't appear to have raised them sufficiently to slow the economy yet."
So, what'll the Fed do next?
Tuesday's report is piling on a sense of urgency to get inflation under control by any means necessary. Most observers expect Jay Powell to announce yet another three-quarter-point hike, though the odds of a full-point hike — pretty much unthinkable before this week — aren't insignificant.
Nomura economists on Tuesday adjusted their forecast for the Fed's September meeting from a 0.75 percentage point hike to a full 1-point hike, writing that "a more aggressive path of interest rate hikes will be needed to combat increasingly entrenched inflation," according to Bloomberg.
Investors are pricing in a 22% chance of a full-point move next week, according to the CME Group's Fed Watch tool.
BOTTOM LINE
The recipe for the Fed is to stay the course and keep raising rates, which should eventually bring prices down as consumers and businesses get put off by higher borrowing costs. But it looks more and more likely that the Fed will only be able to do that by smothering demand so much that the economy crashes into a recession, a la Paul Volcker in the early 1980s. Powell and company are making a calculated bet that the short-term pain of a recession is preferable to the long-term pain of letting inflation run rampant.
READ MORE: Grocery prices have surged 13.5% over the past year, the largest increase since 1979. Egg prices are up nearly 40%. Flour, 23%. Milk and chicken cost about 17% more.
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