Editor’s Note: Morning Money is a free version of POLITICO Pro Financial Services morning newsletter, which is delivered to our s each morning at 5:15 a.m. The POLITICO Pro platform combines the news you need with tools you can use to take action on the day’s biggest stories. Act on the news with POLITICO Pro. The risk of an election-year recession just got a little more real. Inflation hit another four-decade high in January, as price increases spread to virtually every spending category , the Labor Department said Thursday. The report, which came in above economists’ expectations, puts pressure on the Federal Reserve to respond with bigger and more frequent interest-rate hikes this year to tame inflation. Respond too aggressively, however, and officials could slow the economy down so much that it tips into a recession. That would spell disaster for Democrats and the White House, whose policy agenda has already been derailed by persistently higher prices. “The Fed has a very narrow path to guide the economy back to one where inflation is lower but growth does not slow meaningfully, and I think that the path got even narrower” with the latest inflation data, Deutsche Bank chief U.S. economist Matthew Luzzetti tells MM. Luzzetti and his colleagues revised their forecast after Thursday’s data, now projecting the Fed will raise short-term interest rates by half a percentage point at its March 15-16 meeting, up from the quarter-percentage-point rise they previously expected. They also expect policymakers to raise rates by a quarter percentage point at every other meeting this year, except for November. Goldman Sachs economists on Thursday also increased their forecast for rate increases, to seven consecutive quarter-percentage-point hikes in 2022, from the five they expected before the latest inflation report. Stocks tumbled and bond yields rose as markets digested the inflation data and what it means for the path of Fed policy. Fed-funds futures markets now see a nearly 90 percent chance that officials raise rates by a half percentage point in March, up from roughly 24 percent odds the day before, according to CME Group. “We have believed that FOMC participants have little inclination to pursue a 50-basis-point hike unless they were ready to declare an emergency,” former Fed governor Larry Meyer said in a note to clients. “However, it changes the calculation significantly that the market is virtually asking for 50.” A recession? Really? — To be clear, forecasters and Fed watchers aren’t seeing the U.S. economy deteriorating. On the contrary, it’s booming: Gross domestic product rose at a 6.9 percent annual rate in the fourth quarter, employers have added more than half a million jobs a month on average over the past three months, and wages and salaries rose 4.5 percent last year. But that success, which the White House has repeatedly touted, has come with a nasty side of inflation, as strong consumer demand has collided with supply chain bottlenecks. While many economists, including Fed officials, continue to expect that inflation will begin to ease over the coming months, there are also growing concerns — which Thursday’s CPI report did little to allay — that price pressures are becoming more widespread and potentially more persistent. Which brings us back to the Fed — “What we’re talking about now is the Fed really having to slam on the brakes,” Grant Thornton chief economist Diane Swonk tells MM. “And when you slam the brakes quickly, you can trigger an accident.” Credit conditions have worsened some since the Fed made its abrupt policy pivot late last year, as markets price in the prospect of greater tightening and slower growth. But monetary policy is still very accommodative — interest rates are still low and the Fed’s balance sheet is still elevated — and it could take time before rate increases actually weigh on the economy. Luzzetti and his colleagues still put the odds of a recession this year below 50 percent but said a more aggressive Fed clearly raises recession risks in 2023 and 2024. “For a while, we have believed the biggest risk to growth was if the Fed had to undertake a more aggressive tightening of monetary policy to tame inflation pressures,” he said. “And I think very clearly with this morning’s data, the risk of that has risen.” Not everyone is convinced the CPI data moves the Fed much — “Today’s report was not encouraging, but it’s premature to conclude that the Fed will move [up rates by half a percentage point] next month,” Roberto Perli, head of global policy research at Piper Sandler, tells our Victoria Guida. “Even if the next report were to show strong price pressures, I think the Fed will be wary to make an aggressive first step in order not to risk destabilizing markets.” IT’S FRIDAY — Six weeks down, 46 more to go. If you’re in D.C., enjoy that 63-degree high today! Let us know what we should be writing about next week: kdavidson@politico.com, aweaver@politico.com, or on Twitter @katedavidson and @aubreeeweaver.
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