Strong ECI, GDP Reports Raise Prospect of More Aggressive Fed

Inflation worries may mean that Alan Greenspan and his merry band will hike rates by more, and at a quicker pace, than the market's expected.
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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.