over 1 year ago • 3 mins
The Federal Reserve (The Fed) has been finding out that even “jumbo” nudges in interest rates aren’t going to put a dent in high inflation. It’s going to need to put its back into this.
✍️ Connecting The Dots
The Fed has two responsibilities: keep employment full and inflation around a low and stable 2%. With the job market in good shape and unemployment near pre-pandemic lows, tamping down the country’s high inflation is the Fed’s top priority. And as the central bank’s emphasized several times lately, it’s willing to do whatever it takes to make that happen – as evidenced by its two back-to-back “jumbo” rate hikes of 0.75 percentage points this summer.
Problem is, inflation is proving to be stickier than initially thought. And that became abundantly clear in the inflation report out Tuesday, which was pretty bad no matter how you look at it. First, the annual inflation rate came in at 8.3%, higher than the 8.1% economists were expecting and still stubbornly close to a four-decade high. Second, consumer prices increased 0.1% in August compared to July, defying expectations for a 0.1% drop. Third, core consumer prices, which exclude volatile energy and food components, rose 0.6% from the month before and 6.3% from the year before. Both these figures topped forecasts, with the yearly rate accelerating for the first time in six months.
That core inflation number is particularly important: the Fed wants to see months of evidence that core consumer prices are coming down before it slows down its rate-hiking campaign. But the US economy is so far showing surprising resilience in the face of the fastest inflation and interest-rate hikes in a generation. That’s partly because wage gains, though lagging inflation, are still extremely elevated. What’s more, with gasoline prices down 10% in August from the month before, Americans are stepping up their discretionary spending elsewhere.
1. A jumbo hike next week is a done deal.
After Tuesday’s inflation report, traders moved to fully price in another large-scale 0.75 percentage point hike from the Fed next week, which would make it its third supersized rate hike in a row. Some are predicting an even more aggressive strategy, thinking there’s a roughly 30% chance the Fed could hike rates by a full percentage point. All in all, traders expect the key fed funds rate to peak at about 4.5% next year, about twice what it is now.
2. There could be more pain for stocks ahead.
Ray Dalio – the billionaire founder of the world’s biggest hedge fund – came out with a gloomy prediction this week: a fed funds rate near 4.5% would lead to a nearly 20% plunge in stock prices. The legendary investor also said investors are still too complacent about long-term inflation. Along with other signals in the market, this suggests you might want to still position your portfolio defensively and be patient. Not every rally is the start of a bull market, so don’t fall prey to FOMO (fear of missing out) on the trading days when the market is up.
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