WHAT WILL THE FED DO ABOUT INFLATION?

The Fed is walking a razor’s edge between rising inflation and a potential recession. So-called fedologists have been working overtime trying to predict policy changes that will have a big impact going forward.

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Inflation has been a problem for quite some time now and there are reasons to think it could get worse. Supply chain backlogs are being exacerbated by the war in Ukraine, Covid lockdowns in China, and household savings are winding down from their Covid-era nest eggs.

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Prices are significantly up for key economic inputs like oil, grain, fertilizer, industrial minerals, and semiconductors. All this is happening when labor markets are already very tight.

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I have been watching Fed signals along with other financial professionals. Fed Chairman Jerome Powell is taking a gentle approach by tightening the money supply in small increments.

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Clearly, he would rather see inflation survive a bit longer than risk triggering a sharp recession. He’s also hoping that the market’s anticipation of tighter money will inspire a market correction, without him actually needing to hike interest rates dramatically.

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This is understandable, but I don’t know if it’s sustainable. The Fed prefers to use a soft touch, especially with an election coming this fall. Recessions hurt.

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However, inflation also has a big downside, and I wonder if Powell may need to shift into a new role, soon. Price stability is one of the Fed’s core mandates, along with full employment. And we’re already at full employment.

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It’s clear that interest rates will need to continue rising. The only question is how much and how quickly. Rates are still quite low by historical standards. When we factor in high inflation, real interest rates are even lower still.

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As borrowing costs rise, I expect the growth in many asset prices will slow as well. This transition in the markets is just getting started, and I’ll be keeping a close eye on developments.

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Alliance has a variety of investment strategies that allow us to succeed in any interest rate environment. We will continue monitoring the situation and adjusting our investment strategies to match the market conditions.

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