Economic Data Begins to Reflect the Consequences of the Red Sea Crisis. How Will the Fed Respond?

The S&P Global PMI Delivery Times Index showed the presence of delays driven by the disruptions in the Red Sea. Longer delivery times have been a leading indicator of rising goods inflation.

Detailed sector data further showed that half of the 14 sector and sector groups, for which suppliers' delivery times data are available, experienced a renewed lengthening of lead times in January. Producers of both basic materials and consumer goods witnessed suppliers' delivery times lengthening in January after having improved for 12 and 11 successive months, respectively. Of which, the construction materials sector saw the sharpest downturn in vendor performance.

The timing of the Red Sea event coincides with a shift from destocking to replenishment in the US. The renewed expansion in demand could fuel inflation.

Last week's consumer-price index and producer-price index reports both pointed to an unexpected increase in price pressures in January following months of mostly cooling inflation.

Price increases were particularly large in labor-intensive services such as medical care and car repair, suggesting those employers felt compelled to raise prices to keep pace with the increased cost of workers.

Besides, according to S&P, although service sectors remained at the head of the rankings in terms of cost increases, various manufacturing sectors have also started to see a renewed increase in cost pressures. The report shows a rapid increase in the cost of beverages and food deserves close attention due to its significant influence on overall consumer inflation. Worldwide, food prices have surged at the quickest rate seen in four months, propelling the inflation of output prices within the food production sector to its peak since September 2023.

Finally, sectors experiencing substantial rises in input costs that cannot transfer these additional expenses to their customers should also be closely monitored. These industries are often the most susceptible to declining demand if cost inflation exacerbates due to geopolitical or other disturbances.

On February 16, as the whistleblower on high inflation in the United States, former Secretary of the Treasury Larry Summers stated bluntly in an interview that the Fed's next step is likely to be to raise interest rates rather than lower them. He said the probability is 15%. He believes that the Fed must act "very carefully."

It's not just Summers; several Wall Street investment banks have also warned investors about the risk of the Federal Reserve raising interest rates. Analyst Kit Juckes from Société Générale believes that the Federal Reserve has "no reason to rush" into cutting rates. If the U.S. economy picks up speed again, then the Fed's next interest rate decision could be an increase rather than a decrease.

Mark Nash, macro fund manager at British asset management giant Jupiter Asset Management, believes that the probability of the Federal Reserve raising interest rates rather than cutting interest rates reaches 20%. He believes that strong consumer demand and the prospect that companies may increase spending may once again exacerbate the risk of inflation.

In a research report last week, the US economics team at Deutsche Bank suggested that compared to the forecasts of the FOMC, the US economy may experience a lower unemployment rate and a slower pace of inflation cooling. This could potentially lead the Federal Reserve to keep interest rates unchanged this year, and the probability of such an outcome is not insignificant.

At present, the Federal Reserve's monitoring tools indicate that the market expects the Fed's first rate cut is more likely to occur in June, with a probability of 53.0%. The likelihood of a rate cut in March has decreased from around 55% one month ago to 8.5%, while the probability of maintaining the current interest rate in March is as high as 91.5%.

Jawad Mian, the founder of Stray Reflections, a macro consultancy firm that works with global hedge funds and portfolio managers, pointed out in a report that it is worth remembering that during the 2008-2009 period, to combat the economic recession, the Federal Reserve lowered the federal funds rate to near-zero levels. However, while the market was early to anticipate the Fed to start hiking rates, this ultra-low interest rate environment persisted for a lengthy period, with the Fed not beginning to raise rates until December 2015.