Fed ready to bring the pain in inflation fight
Fed ready to bring the pain in inflation fight
Investors took fright after the Federal Reserve (Fed) hiked rates by another 75 basis points to 3.25% and vowed to “keep at it”.
The S&P 500 closed 1.7% lower, while the Treasury curve inverted further as two-year yields topped 4.1% for the first time since 2007. But Fed chair Jerome Powell sought to squash speculation of rate cuts, stressing that policy needs to be “restrictive” and kept there “for some time”.
US central bankers are aggressively tightening policy as inflation remains stubbornly high. Most recent figures show that core CPI climbed 0.6% over August 2022, leaving it 6.3% higher than a year ago. Beyond the elevated level, of particular concern is the increasing breadth of inflationary pressures. By our estimates, just under four-fifths of the basket is increasing by 4% or more on a year-on-year basis.
And the red-hot labour market means there are clear risks that second round effects on wages and prices will cause inflation to become entrenched. The Fed’s best hope is that more American workers return to take the steam out of the labour market. But whilst the participation rate rose from 62.1% to 62.4% in August 2022, it still remains a full percentage point below its pre-pandemic level.
Chair Powell acknowledged this “supply side healing” had not brought down inflation, thereby necessitating further policy tightening. He added that he “wish[es] there were a painless way… to get inflation behind us” but warned “there isn’t”. Updated forecasts from the Fed showed a higher unemployment rate profile and weaker GDP growth. Even so, they fall short of projecting an outright recession despite the “dot plot” signalling rates will rise to 4.4% in 2022 and 4.6% in 2023 (i.e. 150 basis points of tightening).
It’s optimistic to think a recession can be avoided and in our opinion any chance of a soft landing has evaporated. We believe a recession will be needed to bring inflation under control (see, Forget soft landings – how much of a recession is needed to tame inflation?) and forecast the US economy to contract by around 1% in 2023.
Hiking rates to around 4% should be sufficient to do the job and there are signs tighter financial conditions are starting to have an impact. All but one of our six monetary recession indicators (10-year Treasury yield curve, Fed funds rate, real money base, real narrow money supply and real broad money supply) are flashing red.
Once the US economy is firmly in recession, we would not be surprised to see the focus of policymakers shift back to supporting growth. But any pivot is probably still a long way down the track. So long as inflation remains inconsistent with the Fed’s price stability mandate, it is clear that the committee will continue to raise rates until inflation is back under control.
- Why climate investors must prioritise the most affected
- MyStory: How I'm transforming a former prison in Amsterdam
- Infographic: A snapshot of the world economy
- How is inflation affecting the big investment themes of the future?
- What’s the point of COP27?
- How to navigate Asian credit going forward?
The contents of this document may not be reproduced or distributed in any manner without prior permission.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect nor is it to be construed as any solicitation and offering to buy or sell any investment products. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Any security(ies) mentioned above is for illustrative purpose only, not a recommendation to invest or divest. Opinions stated are valid as of the date of this document and are subject to change without notice. Information herein and information from third party are believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Derivatives carry a high degree of risk. Exchange rate changes may cause the value of the overseas investments to rise or fall. If investment returns are not denominated in HKD/USD, US/HK dollar-based investors are exposed to exchange rate fluctuations. Please refer to the relevant offering document including the risk factors for further details.
This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.