Weekly Brief: The Fed Might Finally Have Convinced Investors That Inflation Is Just A Phase

Weekly Brief: The Fed Might Finally Have Convinced Investors That Inflation Is Just A Phase

over 2 years ago3 mins

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Investors might finally be subscribing to the US Federal Reserve’s view that the recent uptick in inflation is just a phase it’s going through.

🕰 Recap

  • The prices of commodities hit their highest levels in almost a decade at the start of May
  • That might partly be why the US inflation rate hit 5% in May – its highest level since 2008
  • But last week, the US Federal Reserve – reiterating its view that the spike in inflation is just a blip – didn’t change its short-term policies
  • The same day, China announced it’d be selling off a load of its industrial metals to put an end to the commodities rally, causing their prices to tumble

✍️ Connecting The Dots

Cheap money from the US Federal Reserve (the Fed) – in the form of ultra-low interest rates and quantitative easing – has been propping up markets for over a year now. So it’s no wonder investors are trying to outguess each other about how soon the Fed will unwind its policies.

The Fed, for its part, has two responsibilities: keep employment full and inflation low and stable. On the employment front, there are still almost 8 million fewer jobs in the US economy than there were before the pandemic. That’s signaled to the Fed that it should stick with its support measures. The latest inflation reading, on the other hand, showed it hit its highest level since 2008 – or 1992 if you strip out often-volatile food and energy prices. That suggests the Fed should raise interest rates to cool down inflation and bring it within its “low and stable” mandate.

But that comes down to whether the Fed thinks the recent inflation uptick is just a blip or here to stay. And last week, the Fed reiterated that it thought it was the former: the central bank argues that the uptick is being caused by temporary factors like supply chain bottlenecks and a red-hot rally in commodity prices – a rally that’s bound to reverse. The Fed chairman even pointed to the recent plunge in lumber’s price as proof that commodity prices – and by extension inflation – will come down eventually.

All to the good, then, when China announced the same day that it’s selling off a load of its industrial metals from its own stockpiles to put an end to the commodities rally. That caused commodity prices across the board to tumble a day later. Expect the Fed to send a thank you note to China…

🥡 Takeaways

1. The US economy is still a long way away from the Fed’s dual mandate

If this spike in inflation is just temporary and the unemployment rate is higher than the Fed wants it to be, the Fed’s decision to stick to its economic support measures is vindicated. But the question now is when those targets will be met. The Fed reckons by 2023, and last week it hinted that it would’ve raised interest rates twice by then. That’s sooner than most investors had expected.

2. Potential rate hikes sent ripples throughout markets

The more aggressive signal from the Fed sent stock prices downwards and sent ripples through other markets. Bonds declined because potentially higher interest rates on future bonds would make current ones less attractive. Gold declined because it generates no income and therefore becomes less attractive to hold when interest rates increase. And finally, the dollar rose because a potentially higher interest rate on the currency makes it more attractive to international investors and savers.

🎯 Also On Our Radar

Investment bank JPMorgan agreed to buy UK digital wealth platform Nutmeg last week. As a so-called “robo-adviser”, Nutmeg manages almost $5 billion worth of customers’ money online, rather than relying on the typical in-person interactions of the wealth management industry. The acquisition – which will give JPMorgan access to Nutmeg’s 140,000 customers – comes ahead of the investment bank’s entry into the UK retail market this year under its Chase brand.

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