It is imperative for the US Fed to raise interest rates and steadily tighten monetary conditions given that inflation is 40 years high and core PCE inflation is 30 years high, said Prasenjit K Basu, chief economist , ICICI Securities. †

Amid rising inflation in the United States, at its highest point in 40 years, and undiminished concerns over the war between Russia and Ukraine, the US Federal Reserve is all set to raise interest rates at the upcoming FOMC meeting (Federal Open Market Committee). Markets expect a quarter-point rise, marking the first time since 2018 that the US Fed has raised interest rates. Fed Chair Jerome Powell recently indicated he will support a 25 basis point hike, and broader market consensus is also in line with his view. According to CME Group’s FedWatch tool, 97.3% of participants at the April meeting supported a 25 basis point increase.

Given that inflation is at its 40-year high and core PCE inflation is at its 30-year high, it is imperative for the US Fed to raise interest rates and steadily tighten monetary conditions, Prasenjit K Basu, chief economist, ICICI Securities told The Fed is set to aggressively raise interest rates this year, starting at its March FOMC meeting, and will be required to raise Fed Funds interest rates at each of its remaining meetings this year, he said. In fact, this will bring the target Fed Funds rate to 1.75% by the end of 2022 — meaning there will be at least one 37.5bp hike to normalize rates, Basu added.

Inflation amid heated supply chain

Already heated supply chain disruptions have been exacerbated by the conflict between Russia and Ukraine, and oil prices have risen by more than 25% since then. The region is one of the largest exporters of raw materials and energy worldwide, especially for oil, gas, commodities, metals and wheat. “The supply-side disruptions, the recent increase in oil prices, will have an impact on prices in the short to medium term,” said Arun Malhotra, founder of CapGrow Capital Advisors.

“If we have an ongoing disruption in energy and food supplies, it will put upward pressure on inflation,” Brett Ryan, a senior US economist at Deutsche Bank, told Reuters. “That…means consumers will have less income to spend on other goods and services, and that’s typically what slows the economy and creates recession risks.”

Political challenge for Joe Biden

Rising inflation will also worry the administration of US President Joe Biden, which faces midterm elections in November. Basu of ICICI Securities said that while the US will not be significantly affected by the war between Russia and Ukraine, as it is currently a net exporter of oil and gas, it will instead benefit from higher oil prices. “High gas prices at the gas stations will be a major political challenge for President Biden and Democrats in the November 2022 midterm elections, so they have a strong incentive to drive down headline inflation,” he added.

The FOMC meeting is scheduled for Tuesday and Wednesday, and markets will know the direction of the US central bank’s monetary policy on Wednesday, Washington time.

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