Renewed rates fears adds to worries the US will "slam into recession"

(Alliance News) - US interest rates will likely peak at a higher level than previously anticipated due to economic data that came in stronger than recent trends suggested, US Federal Reserve Chair Jerome Powell said on Tuesday.

AJ Bell analyst Russ Mould said it was the news that investors didn't want to hear, with Powell making it "perfectly clear" that US interest rates would keep going up, "potentially faster and harder than markets had previously priced in."

The Fed chair noted that January figures for employment, consumer spending, manufacturing production and inflation pointed to a partial reversal of earlier softening trends.

"If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes," Powell said.

The US central bank has raised its benchmark lending rate eight times since early last year, as the Fed contends with inflation that remains stubbornly above its long-term target of 2%.

However, despite its forceful moves, a key US inflation measure - the personal consumption expenditures price index - rose slightly to reach an annual rate of 5.4% in January from 5.3% in December.

The rate of PCE inflation came in markedly ahead of the FXStreet cited consensus of a slowdown to 4.9%. Further, core PCE inflation, the Federal Reserve's preferred price gauge, quickened to 4.7% on-year in January, from 4.6% in December.

At the same time, the US labour market remains "extremely tight" to use Powell's own words.

US employment growth was well ahead of expectations last month. Nonfarm payrolls rose by 517,000 in January, almost double the 260,000 in December. January's number was well-ahead of market consensus of 185,000.

"To restore price stability, we will need to see lower inflation in this sector, and there will very likely be some softening in labor market conditions," Powell said to the US Senate on Tuesday.

Hargreaves Lansdown analyst Susannah Streeter said the renewed rates fears were adding to worries that the US economy won't "fall like a feather into a mild downturn but slam into a recession."

At 1315 GMT on Wednesday, the ADP US national employment report will be published. Analysts at Lloyds Bank said the report will attract attention as a "potential signpost" to Friday's official jobs numbers, the nonfarm payrolls report for February, which will be released at 1330 GMT on Friday.

"We look for an increase of 200,000 for the ADP measure of private payrolls which, if replicated in Friday's official figures, would suggest the labour market remains tight, adding to speculation of a larger Fed hike later this month," Lloyds Bank said.

According to the CME FedWatch tool, market participants now expect a 71% change of a 50-basis-point hike at the next FOMC meeting. On Tuesday, before Powell's testimony, markets thought there was a 72% chance of a smaller 25-basis-point lift.

Capital Economics analyst Andrew Hunter said that, although most evidence still points to economic weakness and markedly lower inflation this year in the US, he still believes the Fed will begin cutting rates again "sooner than markets are expecting".

"Not only are interest rates set to rise higher than we previously anticipated, but there is now a lot less scope for rate cuts later this year than we had originally thought. Nevertheless, we aren't minded to completely throw in the towel just yet," Hunter said.

"First, a strong January doesn't make a strong year – particularly given the potential impact of the unseasonably warm winter. With most leading indicators flashing red, we still think the economy is likely to fall into recession as the lagged impact of the Fed's cumulative tightening feeds through.

"If we're right that economic growth will be stalling, unemployment rising and core inflation on a clear downward trend towards the end of this year, it's still plausible that those cuts could begin before the year is out."

By Heather Rydings, Alliance News senior economics reporter

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