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While the entire global investment community is apparently very excited about the US Federal Reserve slowing its rate increases to 25 point increments, there are strong reasons for arguing why another 50 point rate hike, or two, are still on the Fed menu.
It was all about last week’s data of course, and while inflation has mostly slowed, it will not go un-noticed by the Fed that the PCE Core Inflator actually rose last month! Adding fuel to the argumentfor the Fed maintaining its 50 point approach for at least another meeting. GDP slowed, but not as badly as feared, and Durable Goods data leapt higher for the month.
While the market has been celebrating weak economic data as a force to generate slower rate hikes, the data may in fact not have been weak enough?
Chairman Powell has reiterated time and time again that demand needs to be drastically reduced and he is not afraid of economic pain. In fact, quietly, he sees this as the solution. If the run of data is not weak enough, there is no solution, and therefore rates have to continue going higher.
One aspect of the economy the Chairman has repeatedly singled out is employment. Employment must be slowed and weakened. Yet, all employment data released last week suggested an on-going strong environment.
So we have an economy, that in the Fed’s perceptions, is most likely not in trouble, where core inflation actually rose last month, with pipeline price pressures still to come, particularly in services and shelter, and rising global oil prices again threatening US gasoline price re-inflation?
This does not a happy, even complacent Fed make.
Tactically, if they were to reduce rates to 25 points at this meeting, only to have revert to 50 points again later, this would represent a fatal blow to an already tarnished Fed reputation after the ’transitory’ fiasco. Which even we were able to recognise in real time was a disastrous miscalculation.
With underlying price pressures remaining persistent, an economy still going reasonably in Q4, and the continuation of a very strong labor market, the Fed may well ascertain that it is indeed close to
reducing its actions in the fight against inflation, but the job is far from done.
Hence, the big risk to markets this week, is that sentiment has failed to appreciate just how historic a fight this is, and that the Fed must win this fight, even at risk of over-doing it.
Should the Fed hike by 50 points, then risk-off responses would quickly follow. Having enjoyed a lengthy rally, stocks could be badly exposed.
The favoured market view of 25 points is a possibility. Though a much smaller one that people think. Should it occur however, markets will most certainly celebrate this fact. With everyone who wants to be long, now further enthused and leveraged long after mis-reading last week’s tea leaves as all positive, it may yet be a case of ‘buy the rumour, sell the fact”.
On either outcome, there is potential for stocks to correct, or begin to correct by the end of this week.
The steadfast forecast here, is the Fed shows the market who is boss and hikes by 50.
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