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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews. 

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The Fed May Not Be Done With Interest Rate Hikes Yet

  • Manufacturing is suffering from softening demand, but other major economic indicators this week pointed to a still resilient American economy.
  • U.S. inflation cooled, but the pace of declines leveled off, which suggests that the Fed still has work to do to bring inflation under control, analysts say

Despite an increase in output in January, the U.S. manufacturing sector has weakened in recent months due to softer consumer demand and higher borrowing costs.   

The slowing manufacturing activity seems to have led to stagnating demand for diesel and other middle distillates in the United States. But other economic data – out this week – showed a resilient economy and job market, suggesting that the Fed could be more hawkish with interest rate hikes to cool inflation. As a rule of thumb, the expected economic slowdown after the hikes is set to weigh on oil demand in the world’s biggest economy. 

U.S. industrial production was unchanged in January after falling 0.6% and 1.0% in November and December, respectively, the Fed said on Wednesday. Manufacturing output actually rose by 1.0%, following two months with substantial decreases. Capacity utilization for manufacturing increased 0.6 percentage point in January to 77.7%, a rate that is 0.5 percentage points below its long-run average.  

Due to the uncertain economic outlook, demand for goods has softened over the past few months, leading to lower manufacturing activity. In addition, input costs for manufacturers have sharply surged. 

This week’s Philadelphia Fed’s Manufacturing Business Outlook Survey showed a sharp – and unexpected – decline in manufacturing output in the Mid-Atlantic region. The index for current activity fell from a reading of -8.9 last month to -24.3 this month—its sixth consecutive negative reading and the lowest reading since May 2020. The survey also showed that manufacturing firms are paying more for materials and charging less for their products—a sign that their margins have become under increased pressure. 

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“The survey’s future indexes continued to suggest tempered expectations for growth over the next six months,” Philadelphia Fed said. 

According to data from the Institute of Supply Management, economic activity in the manufacturing sector contracted in January for the third consecutive month following 28 months of growth. 

“The U.S. manufacturing sector again contracted, with the Manufacturing PMI at its lowest level since the coronavirus pandemic recovery began. With Business Survey Committee panelists reporting softening new order rates over the previous nine months, the January composite index reading reflects companies slowing outputs to better match demand in the first half of 2023 and prepare for growth in the second half of the year,” said Timothy R. Fiore, Chair of the Institute for Supply Management Manufacturing Business Survey Committee. 

Manufacturing is suffering from softening demand, but other major economic indicators this week pointed to a still resilient American economy, which could give the Fed more ammunition to end the rate hikes cycle higher and keep interest rates high for longer.  

U.S. inflation cooled, but the pace of declines leveled off, which suggests that the Fed still has work to do to bring inflation under control, analysts say. Another inflation measure, the Producer Price Index for final demand, rose by a seasonally adjusted 0.7% in January, more than expected by analysts, with higher gasoline prices accounting for nearly one-third of the rise in the index for final demand goods. 

A report showed on Wednesday that U.S. retail sales grew by 3% on the month and by 6.4% on the year in January, the fastest clip in nearly two years and a reversal from a two-month slump. The number of new jobless claims fell unexpectedly last week, indicating that the labor market continues to be strong. 

In view of the still sticky inflation and signs of a resilient economy, the market has now started to price in that the Fed may have to raise rates higher and for longer than expected last year.  

“There’s a good chance the Fed does more than the markets expect,” Bruce Kasman, chief economist for JPMorgan Chase, told Bloomberg.

Loretta Mester, Cleveland Fed’s President and Chief Executive Officer, said this week, “At this juncture, the incoming data have not changed my view that we will need to bring the fed funds rate above 5 percent and hold it there for some time to be sufficiently restrictive to ensure that inflation is on a sustainable path back to 2 percent.”  

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According to Ed Moya, Senior Market Analyst, The Americas at OANDA, “A strong dollar could emerge following a steady flow of hawkish Fed speak and that should keep any oil price rallies capped.”

“It is going to be hard for oil to break out here until we see clear signs that China’s reopening is reaching the next level.”  

By Tsvetana Paraskova for Oilprice.com

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