Another hotter-than-expected inflation report is upending hopes of Federal Reserve interest rate cuts this year, in what could be a blow to President Joe Biden’s reelection campaign and parts of the economy most vulnerable to higher borrowing costs. Wednesday’s consumer price index report showed the cost of living increased more rapidly than expected last month. CPI rose by 3.5 percent from a year earlier, more than economists anticipated and more than prices rose in February. Market aspirations for a June rate cut have vanished, with interest rate traders now banking on the first reduction happening in September, according to CME’s FedWatch tool. The hot takes have been unleashed. “You have to take seriously the possibility that the next rate move will be upwards rather than downwards,” former Treasury Secretary Larry Summers said on Bloomberg Television. MM spoke with several experts Wednesday afternoon about which parts of the economy would be most vulnerable in a scenario where borrowing costs remain higher for longer. Krishna Guha, vice chairman of Evercore ISI, said housing and auto sales may take a hit. “Normally you would add business investment," he said. "But some categories there will be less rate sensitive than usual including infrastructure and industrial investment subsidized by Biden fiscal policies and AI-related investment." Unlimited Funds CEO Bob Elliott also pointed to autos but said housing may be somewhat more insulated because of full cash purchases, significant down payments and the likelihood that many home buyers have assets that have been going up in value. He said companies may take a hit if they’ve been banking on a cutting cycle, in particular those that have weak cash flow and are private equity- and private credit-financed. “The overall economy’s pretty strong and has been able to tolerate rates in the ballpark of these levels for a while now,” he said. “But the way tightenings flow through the real economy is they create pressure on those companies or individuals that need to do borrowing.” Rakeen Mabud, chief economist of the left-leaning Groundwork Collaborative, argues that the Fed needs to cut soon. She said gasoline and housing are helping drive rising prices and aren’t something the central bank can tamp down on with higher rates. “It’s really important for the Fed to recognize they are playing chicken with our economy, and they are playing chicken with the lives of millions of people,” she said. Fed Chair Jerome Powell has made clear what the risk is. “We’re in a situation where if we ease too much or too soon, we could see inflation come back,” Powell told reporters last month. “If we ease too late, we could do unnecessary harm to employment and people’s working lives.” But the story of the post-Covid economy is that it’s full of surprises. “The traditional economic models predicted a much larger macroeconomic response to the Fed’s 500-basis point rate increases than what was expected,” Brookings Institution senior fellow Aaron Klein said. “Some may say the underlying economy is stronger than the models thought it would be. But others could look at the data and wonder whether the economy is structurally less interest-rate sensitive.” With an uncertain backdrop, the mantra of Fed officials is that they are data-driven. EY-Parthenon chief economist Gregory Daco wrote Wednesday that there's a growing risk the Fed may cut just twice instead of three times this year “not because it would be optimal, but because several policymakers have become myopically data dependent.” An obvious near-term impact is on voters. Klein said research has shown that voters form their opinion of the economy at this stage of the election cycle, in the spring and early summer. Rep. Stephen Lynch (D-Mass.) told our Eleanor Mueller it’s “not the best environment for the president’s re-election.” (An understatement to be sure.) Biden "doesn't have control,” Lynch said. “And I know he doesn't want to badger the Fed. He's been hands-off — quite different than the previous president. He's trying to respect their role. So I think there are a lot of other issues that he's going to have to talk about.” Other Democrats want Biden to get into it. Rep. Gregory Meeks (D-N.Y.) told Eleanor that Democrats “need to talk about the root causes of inflation.” He includes in that bucket the impact on commodities from the war in Ukraine and the conflict in the Middle East. It's further fuel for Republicans who have focused on inflation as the main line of attack against Bidenomics amid a strong labor market. Rep. Byron Donalds, a Florida conservative who’s a potential Trump VP pick, said “we were right.” “But being right when the country's going to hell is no prize,” he said. “Our hope is that the American people see this as well and they make different choices in six months.” It’s Thursday — Send tips to zwarmbrodt@politico.com.
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