After the Jackson Hole conference, last week’s inflation data removed beyond any doubt any chance that the Fed might soon stop raising interest rates. The consumer price index did come out in August slightly below the July index, but the markets’ expectations were for a greater decrease, following the sharp drop in fuel prices. Beyond that, core inflation (excluding energy and food) came out significantly above expectations, and unfortunately is also considered to be one that takes time to decrease.
The turmoil in the bond market also reached the stock markets and put pressure on the stock markets with the understanding that the Fed is not going to change course anytime soon. The inflation figure added a full increase to the Fed’s interest rate and makes this week’s Fed meeting particularly interesting.
The markets’ pricing for the upcoming increase stands at more than 80% (ie a 75% increase is priced, there is also a chance for a 1% increase) after last week’s inflation figure.
Our view all along was that the markets underestimated the type of inflation, as well as the Fed’s determination to fight inflation and the fact that interest rate cuts are not expected to happen before 2023. But we are really not going out to celebrate in light of the heavy losses in the stock markets. There are very few winners in 2022 so far.
In the end, we will choose the hawkish camp regarding the Fed and the European Central Bank, in light of the fact that there is a fear of a loss of confidence in the central banks, after years of expansionary monetary policy.
Looking ahead, we see that the high volatility is expected to remain for now, after the great calm that prevailed, following the great economic crisis, the debt crisis in Europe, Corona and the geopolitical pressures of 2022.
After the strong inflation figure for the month of August, the probability of an interest rate increase for the third time in a row at a rate of 75% is high, with some economists giving a small chance of an increase at the rate of 1%. The US economy is not slowing down enough to cool prices and bring inflation back to the bank’s 2% target.
At the same time, inflationary expectations continue to fall to their pre-coronavirus level and there are signs of dips, the markets are toying with the idea that the current interest rate hike cycle will end as early as March 2023. We do not share this view in light of the fact that it will take a significantly long time for the Fed to regain lost trust.
Bottom line, given the fact that inflation is sticky, the Fed is expected to raise interest rates by 75 basis points this week and continue to take a hawkish line.
*** The writer is the Chief Economist of Deutsche Bank ***