Yes, inflation needs an answer

There are no two opinions about that. The rate of inflation at 7.9% for Feb-22 is the highest level of inflation seen in last 40 years. Clearly, it is an anomalous situation and needs to be rectified. In the past, the Fed response to any sharp spike in inflation had been to raise the interest rates in the hope that monetary tightness will rein in inflation. That is a very simple response, especially when inflation is consumer spending driven. 

Macros are also conducive

One of the topics that the Fed has often debated over is whether the growth in the US economy is robust enough to handle interest rate hikes. GDP growth has been on upward trajectory, labour conditions are very close to a situation of full employment and consumer spend is back with a vengeance. The evidence is that, despite the sharp rise in prices of a plethora of commodities, there has not been a major dent on consumption patterns. Of course, demand recovery is still uneven, but that is something that has been largely handled by giveaways. In short, there is really not much of a base case for the Fed to put off the rate hikes much further beyond this point. 

Ukraine poses a question mark

The only big event risk that could be a dampener to the rate hike idea is the ongoing war in Ukraine. As of now it looks like the Western pressure is hardly working on Russia’s plans. Meanwhile, the price of crude has rallied over 80% in the last 3 months and Brent crude is close to $130/bbl. As a result, gasoline prices in the US at $4.20/gallon are at an all-time high. While this is a big risk factor for inflation, it also underlines the fear that too much monetary tightness may actually hamper the consumption impetus in the US economy. That is the last thing that the Fed would want. Even Jerome Powell has hinted that Ukraine will have a bearing on FOMC outcomes. 

Rates will still be hiked

More than anything, for the US Fed, the guidance given on rates is a key factor in their credibility. Also, with inflation at 7.9%, the tightening may be subdued but the Fed will not give up altogether. The most likely scenario is that instead of hiking rates by 50 bps in March, the Fed may end up hiking by just 25 bps. That will be good enough to signal to the market that the Fed is keen on reining in inflation back to the 2% level. Also, the number of rate hikes in 2022 may be diluted from 7 to 5. However, as Powell himself indicated, the target rate hikes by the end of 2023 would still stand. Fed stays hawkish; just that it is worried about oil playing spoilsport!