Inflation remains a concern for markets, puts Fed on track for bigger rate hikes

Red-hot US inflation is showing few signs of cooling - it is persistent and is keeping central banks hawkish, in turn, pushing up rates and pushing down equities. This in turn is also pushing the dollar higher.

The US consumer price index, a closely watched inflation gauge, rose by 8.6 percent in May on a year-over-year basis, its fastest increase since 1981, the Bureau of Labor Statistics reported Friday.

The very high 0.63 percent month-on-month (MoM) increase in core inflation was another surprise. The core reading implies that there is no moderation in the core consumer price index (CPI) versus the previous six months.

So here inflation did indeed hit markets and proved to be a big risk.

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US Treasury yields popped on Friday, led by short-term rates, after the release of hotter-than-expected inflation data raised concern over a possible recession. The 2-year rate jumped more than 24 basis points to 3.065 percent, reaching its highest level since 2008.

Stocks sold off 3-3.5 percent and the dollar consequently was strong. Oil prices too remained high and rose for the week.

The Federal Reserve has already signalled its plans for big increases in the benchmark borrowing rate - due this week Wednesday and next month - but chances are rising that the Fed might have to be even more aggressive with inflation being unacceptably high and President Biden adding to the urgency for the Fed to lower inflation. The Fed doesn't have great options and is reluctant to entertain 75 bps hikes.

All these things mean that the Fed will need to come up with something to address the concern that inflation may be getting out of control. So what could that be? It could be stronger language on future hikes - both number and quantum-wise but whatever it is, it won't be good news for markets.