Fed challenge intensifies as inflation ticks higher, SVB concern lingers

Core inflation ticked higher last month, testing the Fed's rate-hike resolve amid the ongoing turmoil from SVB's spectacular collapse.

Updated at 9:52 am EST

U.S. inflation data offered little respite to the Federal Reserve's growing dilemma Tuesday, as consumer price pressures remained stubbornly high over the month of February, challenging the central bank's effort to stabilize the domestic banking sector.

The headline consumer price index for the month of February was estimated to have risen 6.% from last year, down from the 6.4% pace recorded in January and largely matching the Street consensus forecast of 6%.

On a monthly basis, inflation was up 0.4%, the BLS said, compared to a 0.4% reading in January, the June peak of 1.3% and the Street forecast of a 0.4% acceleration.

However, So-called core inflation, which strips-out volatile components such as food and energy prices, rose 0.5% on the month, and 5.5% on the year, the report noted, with the key monthly reading topping Street forecasts.

The core inflation gain suggests the Fed may find itself challenged by the need to continue raising interest rates in order to tame historically high price pressures, while at the same time risking that elevated rate could trigger deeper stresses in the domestic financial sector following the collapse of tech lender SVB Financial last week and the spillover declines in regional and major U.S. banks.

"Tuesday's elevated inflation report adds to the Federal Reserve's challenges. The Fed has to face the fact that its rate hikes have not only failed to control inflation, but they have started to cause instability in the banking system," said Nancy Davis, founder of Quadratic Capital Management and portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund (IVOL) - Get Free Report.

"The Fed is now a very difficult spot and is running out of good choices," she added. "They need higher rates to fight inflation, but higher rates could continue to spark problems in the banking sector."

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U.S. stocks were trading firmly higher following the data release, with the S&P 500 rising 60 points in the opening hour of trading while the Dow Jones Industrial Average booked a 325 point advance. The tech-focused Nasdaq was up 205 points.

Benchmark 10-year Treasury note yields were 15 basis points higher at 3.670% in volatile trading while 2-year notes were pegged at 4.365%, after hitting a session low of 3.99% yesterday amid the biggest single-day decline since 2008.

The U.S. dollar index, which tracks the greenback against a basket of its global peers, was marked 0.32% higher at 103.92.

The CME Group's FedWatch is now pricing in an 86.4% chance of a 25 basis point Fed rate hike on March 22, up from 30.2% last week, with the odds of a follow-on hike in May -- either 25 or 50 basis points -- pegged at around 83.5%.

SVB Financial's collapse late Friday triggered a coordinated effort by the U.S. Treasury, the Federal Reserve and the Federal Deposit Insurance Corporation to both protect bank deposits and shore-up concerns for the safety of regional lenders around the country.

Bank stocks were pounded again yesterday, however, as fears of contagion from the SVB failure ripped through markets around the world, clipping more than $90 billion in value from the biggest U.S. banking stocks in a single session.

The benchmark The KBW Bank Index, in fact, fell 12% yesterday, its biggest single-day decline since the summer of 2020.

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Investors were also busy re-pricing interest rate markets amid speculation that the Federal Reserve, which is now offering one-year term loans to domestic banks in exchange for top-quality Treasury, agency and mortgage backed securities, may be forced to pause or even abandon its inflation fight in order to prevent the simmering crisis from turning into a full-scale bank run.

"Should the Fed pause the rate hike agenda now, it puts them at risk of exposing themselves to inflation speeding up again," said Nigel Green, CEO and founder of London-based deVere Group. "And then they would be forced to make larger hikes later, which would harm their objective and dent their credibility, so they can be expected to err on the side of caution."