Inflation is showing no signs of letting up, as the Federal Reserve gets ready to raise rates.

February’s consumer price index was up 7.9% year over year, the hottest since January 1982 and just above a Dow Jones estimate of 7.8%. The gain was due to broad-based price jumps in areas of basic needs for consumers — food, fuel and shelter — and it comes as the war between Russia and Ukraine rages on, continuing to drive energy prices higher. Some economists expect inflation to rise even more going forward.

But, even with the uncertainty surrounding the war, the Fed is expected to move forward with its first rate hike next week in a bid to curb inflation before it becomes too entrenched. The Fed took its fed funds target rate to zero in early 2020 to fight the pandemic.

However, the central bank also faces the risk that higher interest rates and high inflation — particularly from energy prices — could create a drag on growth. That means the central bank could have to slow the pace of hiking to prevent a recession.

Economists expect the Fed will raise interest rates as many as seven times this year. In the futures market, traders were betting Thursday on about six quarter-point hikes for the year. That could change once investors see what Fed officials forecast for interest rates, when they release their latest economic projections at the end of their policy meeting Wednesday afternoon.

The Fed’s first rate hike is expected to be a quarter-point, or 25 basis points. Each basis point equals 0.01 of a percentage point.

“25 basis points next week seems just about a lock,” Wells Fargo director of rates strategy Michael Schumacher said. “The Fed’s in a tough spot. It’s getting tougher by the day. It’s hard any time, but especially when you’ve got incredible inflation, and we’ve had the supply chain issues for a while, and now they’ve been exacerbated by Russia-Ukraine.”

The closely watched U.S. 10-year Treasury yield rose to 2% on Thursday. That yield is important since it influences mortgages and other consumer and business loans. At the same time, stocks sold off.

“You’re not seeing the typical risk off reaction. Equities are driven by Ukraine worries, and bonds are driven by inflation and Fed expectations,” Schumacher said. Bond yields move opposite price.

Meanwhile, Gasoline in the past week has jumped by about 60 cents per gallon to an average $4.31 nationally, according to AAA. Oil is off its highs, but is still trading well above $100 per barrel.

Other commodities like wheat, palladium and nickel have also moved. Russia is a major commodities exporter, and sanctions on its financial sector by the U.S. and allies have created concerns about supply scarcity.

The Fed was under pressure from rising inflation to raise interest rates even before the Ukraine situation sent the price of oil and raw materials higher. Supply chain disruptions were behind some rising prices, and a strong U.S. economy with solid growth and a healthy labor market was adding to pressures on prices.

Economists have downgraded U.S. growth expectations, but only slightly, and they do not expect a recession this year. Economists surveyed in the CNBC Rapid Update have an average growth forecast of 3.2% for 2022, down 0.3% from their February forecast.

“With the demand side so strong, I think the Fed is stuck. The Fed focuses on core, but food was up 1% last month. That’s a huge number,” Schumacher said. Energy was the biggest contributor to price gains, up 3.5% for February, accounting for about a third of the headline gain.

Shelter, which includes rent, was up 0.5% for an annualized jump of 4.7%, the fastest increase since May 1991.

February’s core consumer inflation, excluding food and energy, was up 6.4% year over year.

“March CPI will show a substantial 1-2% MoM increase in headline CPI due to higher food and energy prices, with some possible greater than usual pass through of higher energy costs to core inflation in components like transportation services,” Citigroup economists noted. “This next CPI release will come just ahead of the May FOMC meeting, when we expect a 50bp rate hike.”

Many economists expect the Fed to stick to quarter-point rate hikes. But Citi economists said the Fed could raise by 50 basis points at its May meeting after seeing the expected strong report for March. Inflation was expected to have peaked by March, but higher oil prices could mean rising prices could continue to soar.

Economic momentum

“We came into this with a lot of momentum. Oil price spikes don’t always cause recessions,” Grant Thornton chief economist Diane Swonk said. “The Fed has to hedge against what else it’s worried about. That is inflation expectations have been moving up. The Fed has to think about what are the chances of this inflation more entrenched like the 1970s. They are trying to avoid that at all costs.”

Swonk said the Fed was already behind the curve, and it needs to raise rates. She said headline CPI could easily reach 9% this spring before falling off.

Rising oil prices are a big concern for economists since they snake through the economy, hitting the consumer at the gas pump. The high prices are also generating higher input costs for things like chemicals, fertilizers, plastics and building products. They are also a drag on the transportation sector, as they drive diesel and jet fuel prices higher.

So oil prices could play a big part in the Fed’s decision making process. Economists are not currently forecasting super high oil prices, but they don’t rule out a higher spike.

“I think if oil went to $150 and you saw some break in the data somewhere, they might skip May for a hike,” Barclays chief U.S. economist Michael Gapen said. “They would presumably be thinking we’re seeing some deterioration in demand.”

What could stop the Fed

Worries about stagflation have crept into the market.

“We certainly have stagflation influences. Stagflation is literally rising inflation and rising unemployment. I don’t think that’s probable at this point. It’s certainly plausible. We certainly have stagflation influences,” Gapen said. “You would need the conflict to widen beyond its current context. Maybe that puts Europe into a recession and it would be hard for us to stay out of a recession.”

Gapen said the data would have to deteriorate for the Fed to slow its rate hikes. He expects five hikes, and the Fed is also expected to begin to pare down its roughly $9 trillion balance sheet this year, also a tightening move.

Swonk noted that the employment picture is solid. The 678,000 jobs added in February was especially strong, and the labor market continues to improve.

There are, however, other issues that could stop the Fed in its path to normalize rates.

Swonk said that if financial conditions became poor, with stocks selling sharply and credit markets freezing up, that could give the Fed pause. So far, there are no signs of major stress in financial markets from the Russian-Ukraine crisis.

“What would stop the Fed is if we had a situation that really bled into credit markets. In a way, that creates worse inflation and it’s much harder to recover from a financial crisis. That’s why the Fed’s walking a tightrope,” she said.

“They couldn’t have broadcast this more,” she said. “Jay Powell said we’re going to raise rates a quarter point on March 16. That was as blunt as you could get. They’re on for that. They don’t want it to be a surprise.”

Swonk said it’s not clear what the Fed will forecasts about future rate hikes. “But they have to put in the caveat that we’ll be watching financial markets carefully,” she added.