Is the Fed Done Hiking or Should Markets Worry About Inflation Creeping Back Up?

by Pedro Ferreira
  • Could a new rate hike be on the cards?
blackrock

Few elements are as important as central bank choices and policies. The Federal Reserve, also known simply as the Fed, plays a critical role in the global financial system. Its decisions, particularly those relating to interest rates, have a significant impact on a variety of assets as well as the broader economic situation.

The question that has been lingering in the minds of market players and economists alike is whether the Fed has finished raising interest rates or if the possibility of inflation is resurfacing.

Understanding the Federal Reserve's Dual Role

The Fed is mandated by Congress to achieve maximum employment while also maintaining stable prices, which is known as the inflation mandate. To achieve these goals, the Fed employs a variety of measures, including open market operations and changes in the federal funds rate.

In recent years, the emphasis has mostly been on the mandate's inflationary component. The Fed has been dealing with persistently low inflation, raising fears that the economy would enter deflationary terrain. To fight this, the central bank implemented a near-zero interest rate policy and engaged in a series of quantitative easing programs, which entailed purchasing financial assets such as bonds in order to pump liquidity into the financial system.

The Rate Hike Era

The economic situation, however, has transformed. The United States, like most of the rest of the globe, has been experiencing rapid economic development, with unemployment reaching historic lows. As a result, the Fed launched a series of interest rate hikes to keep the economy from overheating and inflation from exceeding its 2% target.

The market was carefully informed on the gradual path of rate hikes, with the central bank underlining its data-dependent approach. This meant that the Fed would make choices and alter its policies depending on the most recent economic data.

Recent Happenings

As 2022 approached, the Fed began to normalize its monetary policies. It began to reduce its bond purchases, signifying a diminution in monetary accommodation. The markets were looking for hints about the timing and pace of interest rate hikes.

The Fed ultimately delivered the anticipated 25 basis point interest rate hike in December 2022, ushering in a new chapter in its monetary stance. This action was widely anticipated, but the key question remained: would the Fed continue to raise interest rates, and if so, how quickly?

Concerns About Inflation

Concerns over rising inflation have been one of the key motives of the Fed's recent measures. For some months, inflationary pressures have been building, spurred by factors such as supply chain disruptions, labor shortages, and rising energy prices. These cost-push inflationary forces have contributed to increasing prices for products and services, reducing the purchasing power of consumers.

The Fed's inflation mandate, paired with mounting price pressures, has prompted many to believe that the central bank may need to expedite rate hikes in order to battle inflation. Some experts say that a more forceful posture is needed to anchor inflation expectations and avoid a prolonged period of high prices.

US Inflation on Track, Implications for the Next Rate Hike

US inflation figures for September revealed a slightly higher-than-expected rise in headline prices, marking a 0.4% increase month-on-month and a 3.7% rise year-on-year. The consensus forecast had been slightly lower at 0.3% MoM and 3.6% YoY. Simultaneously, the core rate, excluding food and energy, aligned with expectations at 0.3% MoM and 4.1% YoY. The increase in gasoline prices, up 2.1% for the month, had already hinted at this outcome.

Although these numbers prompted a slight uptick in Treasury yields, we shouldn't overlook the broader context. Housing costs continue to rise, up 0.6% MoM, yet given the correlation with housing rents data, this is likely to slow in the near future.

Super core inflation, a measure that excludes shelter and energy, remains relatively high, with a 0.6% MoM increase. However, areas such as medical care, education/communication, apparel, and used vehicles are showing positive signs. Some segments, like recreation, may be tied to seasonal activities and are expected to decline, impacting consumer discretionary spending.

The rising prices of hotels and motor vehicle insurance, part of the super core rate, have played a significant role in this increase. The Federal Reserve closely monitors this figure, but this trend isn't expected to continue.

The market has slightly adjusted its expectations regarding a rate hike by December, but the likelihood remains doubtful. Fed officials emphasize the significance of rising Treasury yields in tightening financial conditions, potentially negating the need for another rate increase. Given the current high mortgage rates and credit card borrowing costs, monetary policy seems sufficiently restrictive. Furthermore, corporate pricing surveys hint at an upcoming softening, leading us to anticipate a gradual slowdown in inflation over the next few quarters.

The Game of Tug of War

The Fed is presently in a delicate balancing act. On the one hand, it must respond to inflationary pressures by gradually increasing interest rates in order to chill the economy. However, it must avoid impeding economic growth and producing excessive market turmoil.

The communication of the central bank will be critical in shaping market expectations. The pace and extent of future rate hikes will be closely watched, since any surprises could cause market instability. Furthermore, the Fed's capacity to effectively forecast the trajectory of inflation and employment will be critical in its policy decisions.

Implications for the Market

As the financial markets manage the uncertainties around the Fed's decisions, they are on high alert. Investors are looking for any indications from the Fed about the timing of future rate hikes. The Fed's decision on how quickly to raise interest rates will have a direct impact on various asset classes.

Equity markets, which have been on a long winning streak thanks to low interest rates, may encounter headwinds when rates rise. Higher borrowing costs might diminish business profitability and make stocks less appealing in comparison to fixed-income assets.

Bond prices, on the other hand, tend to fall as interest rates rise. Longer-term bond investors may see the value of their portfolios decline as interest rates rise.

Changes in interest rate differentials also affect the foreign currency market. A more active Fed might result in a stronger US dollar, which would influence trade dynamics and potentially create headwinds for international firms.

Conclusion

As the Finance Magnates London Summit approaches, the Fed's monetary policy and its consequences for financial markets are expected to take center stage. The function of the central bank in balancing the twin aims of maximum employment and stable prices is crucial in defining the economic landscape.

The Fed's next steps will necessitate careful evaluation of changing economic conditions and inflationary pressures. The Fed's decisions will surely have far-reaching consequences for markets and investors. As a result, market investors will closely scrutinize the Fed's every move and announcement in the coming months in order to forecast the direction of interest rates and the larger economic landscape.

Few elements are as important as central bank choices and policies. The Federal Reserve, also known simply as the Fed, plays a critical role in the global financial system. Its decisions, particularly those relating to interest rates, have a significant impact on a variety of assets as well as the broader economic situation.

The question that has been lingering in the minds of market players and economists alike is whether the Fed has finished raising interest rates or if the possibility of inflation is resurfacing.

Understanding the Federal Reserve's Dual Role

The Fed is mandated by Congress to achieve maximum employment while also maintaining stable prices, which is known as the inflation mandate. To achieve these goals, the Fed employs a variety of measures, including open market operations and changes in the federal funds rate.

In recent years, the emphasis has mostly been on the mandate's inflationary component. The Fed has been dealing with persistently low inflation, raising fears that the economy would enter deflationary terrain. To fight this, the central bank implemented a near-zero interest rate policy and engaged in a series of quantitative easing programs, which entailed purchasing financial assets such as bonds in order to pump liquidity into the financial system.

The Rate Hike Era

The economic situation, however, has transformed. The United States, like most of the rest of the globe, has been experiencing rapid economic development, with unemployment reaching historic lows. As a result, the Fed launched a series of interest rate hikes to keep the economy from overheating and inflation from exceeding its 2% target.

The market was carefully informed on the gradual path of rate hikes, with the central bank underlining its data-dependent approach. This meant that the Fed would make choices and alter its policies depending on the most recent economic data.

Recent Happenings

As 2022 approached, the Fed began to normalize its monetary policies. It began to reduce its bond purchases, signifying a diminution in monetary accommodation. The markets were looking for hints about the timing and pace of interest rate hikes.

The Fed ultimately delivered the anticipated 25 basis point interest rate hike in December 2022, ushering in a new chapter in its monetary stance. This action was widely anticipated, but the key question remained: would the Fed continue to raise interest rates, and if so, how quickly?

Concerns About Inflation

Concerns over rising inflation have been one of the key motives of the Fed's recent measures. For some months, inflationary pressures have been building, spurred by factors such as supply chain disruptions, labor shortages, and rising energy prices. These cost-push inflationary forces have contributed to increasing prices for products and services, reducing the purchasing power of consumers.

The Fed's inflation mandate, paired with mounting price pressures, has prompted many to believe that the central bank may need to expedite rate hikes in order to battle inflation. Some experts say that a more forceful posture is needed to anchor inflation expectations and avoid a prolonged period of high prices.

US Inflation on Track, Implications for the Next Rate Hike

US inflation figures for September revealed a slightly higher-than-expected rise in headline prices, marking a 0.4% increase month-on-month and a 3.7% rise year-on-year. The consensus forecast had been slightly lower at 0.3% MoM and 3.6% YoY. Simultaneously, the core rate, excluding food and energy, aligned with expectations at 0.3% MoM and 4.1% YoY. The increase in gasoline prices, up 2.1% for the month, had already hinted at this outcome.

Although these numbers prompted a slight uptick in Treasury yields, we shouldn't overlook the broader context. Housing costs continue to rise, up 0.6% MoM, yet given the correlation with housing rents data, this is likely to slow in the near future.

Super core inflation, a measure that excludes shelter and energy, remains relatively high, with a 0.6% MoM increase. However, areas such as medical care, education/communication, apparel, and used vehicles are showing positive signs. Some segments, like recreation, may be tied to seasonal activities and are expected to decline, impacting consumer discretionary spending.

The rising prices of hotels and motor vehicle insurance, part of the super core rate, have played a significant role in this increase. The Federal Reserve closely monitors this figure, but this trend isn't expected to continue.

The market has slightly adjusted its expectations regarding a rate hike by December, but the likelihood remains doubtful. Fed officials emphasize the significance of rising Treasury yields in tightening financial conditions, potentially negating the need for another rate increase. Given the current high mortgage rates and credit card borrowing costs, monetary policy seems sufficiently restrictive. Furthermore, corporate pricing surveys hint at an upcoming softening, leading us to anticipate a gradual slowdown in inflation over the next few quarters.

The Game of Tug of War

The Fed is presently in a delicate balancing act. On the one hand, it must respond to inflationary pressures by gradually increasing interest rates in order to chill the economy. However, it must avoid impeding economic growth and producing excessive market turmoil.

The communication of the central bank will be critical in shaping market expectations. The pace and extent of future rate hikes will be closely watched, since any surprises could cause market instability. Furthermore, the Fed's capacity to effectively forecast the trajectory of inflation and employment will be critical in its policy decisions.

Implications for the Market

As the financial markets manage the uncertainties around the Fed's decisions, they are on high alert. Investors are looking for any indications from the Fed about the timing of future rate hikes. The Fed's decision on how quickly to raise interest rates will have a direct impact on various asset classes.

Equity markets, which have been on a long winning streak thanks to low interest rates, may encounter headwinds when rates rise. Higher borrowing costs might diminish business profitability and make stocks less appealing in comparison to fixed-income assets.

Bond prices, on the other hand, tend to fall as interest rates rise. Longer-term bond investors may see the value of their portfolios decline as interest rates rise.

Changes in interest rate differentials also affect the foreign currency market. A more active Fed might result in a stronger US dollar, which would influence trade dynamics and potentially create headwinds for international firms.

Conclusion

As the Finance Magnates London Summit approaches, the Fed's monetary policy and its consequences for financial markets are expected to take center stage. The function of the central bank in balancing the twin aims of maximum employment and stable prices is crucial in defining the economic landscape.

The Fed's next steps will necessitate careful evaluation of changing economic conditions and inflationary pressures. The Fed's decisions will surely have far-reaching consequences for markets and investors. As a result, market investors will closely scrutinize the Fed's every move and announcement in the coming months in order to forecast the direction of interest rates and the larger economic landscape.

About the Author: Pedro Ferreira
Pedro Ferreira
  • 693 Articles
  • 16 Followers
About the Author: Pedro Ferreira
  • 693 Articles
  • 16 Followers

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