Strong ECI, GDP Reports Raise Prospect of More Aggressive Fed

It's an all-around bad day for those hoping for good news on the inflation front, as the Employment Cost Index rose 1.4%, greater than expected, and the gross domestic product report's inflation indicator, the implicit price deflator, came in stronger than expected as well. Both stock futures and bonds are suffering in the early going, as the report makes a 50-basis point hike from the Federal Reserve more likely.

"This makes the Fed strategy very simple -- they're going to tighten and tighten and tighten till things change," said Mike McGlone, vice president at Aubrey G. Lanston.

The ECI, an important measure of wage costs believed to be the indicator Fed Chairman Alan Greenspan watches closest, rose 1.4% in the first quarter, bringing its year-over-year rate of increase to 4.3%. That's the highest it's been since the fourth quarter of 1991. GDP grew 5.4% in the first quarter, lower than the consensus estimate among economists polled by Reuters for 5.9% growth. But more importantly (and unfortunately), the implicit price deflator, the report's inflation component, was up 2.7%, way ahead of expectations for a 2.2% increase.

The bond market has weakened on the news, with most of the damage in the short end of the curve, where the two-year note is off 3/32 to 99 23/32, yielding 6.536%. Short-dated securities react harshly to expected changes in Fed policy, but the market is already discounting at least a quarter-point hike. In addition, the bond market is factoring in some safe-haven buying from the stock market, which looks in for a nasty opening.

Stock futures got crushed after the news and both the Dow and the Nasdaq have been lower throughout the morning. "The only reason the short end is not getting hammered is because stocks are getting hammered," said McGlone.

The reports up the ante on the possibility of a 50-basis-point rate hike by the Federal Open Market Committee at its next meeting on May 16. Just about all economists believe that the Fed will raise rates at least a quarter point from the current 6%, and after today's reports many may be upping their rate-hike forecasts. Fed Chairman Alan Greenspan's fears that the tightness in the labor market would eventually result in wage cost pressures seems to have come to fruition.