The US Federal Reserve raised rates to 5.5%.
This is a terminal rate that few saw coming. Let alone this quickly. It took a while for Wall Street and the Fed to understand inflation was not ’transitory’ after all.
The changing character of inflation this time round, from post-Covid surges to ongoing supply chain disruption, and then energy and food shocks due to the Ukraine war, was a lot for any central bank.
There was also the process of businesses – big and small – regaining the power to raise prices without losing market share. Something that had not been possible during the prior two decades as globalisation ran its course. Profit margins expanded dramatically.
It must be said the Fed was very late to the party, and therefore had to hike aggressively. In the end, the Fed has in all probability lifted rates too far. The old school textbook approach of just hiking no matter what, has been a very blinkered policy approach
We have warned several times that inflation is a different animal this time. While some raising of rates was absolutely necessary, the Fed did move into a zone where further rate hikes were, we believe, harming the economy more than having any real flow through impact on inflation. Inflation of this kind will be self-defeating. Greater patience is now required.
The problem still for investors is that the Fed remains concerned and could even hike again? Core inflation remains quite extreme, and services prices and wages are major concerns. This should however be a more stable period.
My summation would be that the Federal Reserve should be done, but we still need to keep an eye on rekindling energy and commodity prices, as well as that core inflation number.
Markets should at least be assured that even if the Fed felt it necessary to hike again, it would be unlikely to be a significant series of hikes as before.
These are the highest borrowing costs in 22 years. Steady rates at this level remain problematic for an economy that is not in great shape, except for employment.
Prices are not falling either. Headline inflation is still too high, but at least trending well. It is an important point because it means the tremendous surge in prices over the past two years will remain a very heavy burden on consumers and businesses alike. While there will be no relief from the current high borrowing costs either.
Private credit is being tightened and middle America is finding it increasingly difficult to borrow. We continue to see a significant further slowing in the US economy. While there may be some form of soft landing, the worry is that there will be no follow through take off for quite some time.
The economic matrix of the moment continues to point toward sub-trend growth, skirting with contraction, for perhaps the next 2-3 years.
The US economy is going through a historic readjustment and consolidation phase. It will not be over in a matter of months.
The Fed’s statement was far more neutral than I had expected. So this was a welcome relief. As the Fed moves forward, it is likely both the US and global economy will remain weak. This should be enough to keep the Fed from hiking for perhaps the next 12-18 months.
Please note, it is also likely, that following such a torrid time of hiking and public debate over Fed policy, that the Fed will very much want to keep things calm for as long as possible.
Hence, any hopes of early rate cuts are probably just that. The view here is that the Federal Reserve is now on hold for those next 12-18 months.
Market commentary and analysis from Clifford Bennett, chief economist at ACY Securities
