Normalising rates at a time when inflation is at multi-decade highs and unemployment at cyclical lows poses a tough task for the central bank.
With bond and equity markets having already reacted to the previous Federal Reserve (Fed) meeting and its commitment to withdraw liquidity and raise rates at a more aggressive pace than what had been priced in at the end of last year, its latest meeting and subsequent press conference on 4 May had the potential to be a major market moving event if it deviated from the perceived priced-in market wisdom. On this we saw no deviation and the Fed walked the exact line that was expected, raising rates by 50 bps to 1%. This is the first time the 50 bps hiking hammer has been used since the year 2000 and no less used on 4 May, aka Star Wars day. Jedi knight Jerome Powell and his band of padawans used their force to their fullest but raising rates to combat what is obviously a supply driven inflation issue might seem redundant to most.
We all know it has to be done. Rates need to get back to a more normal level, whatever that level now is, and the experiment in quantitative easing with all its distortions needs to end. But this aggressive tightening and balance sheet reduction is making the soft landing that the Fed is trying to engineer for the economy, a difficult flightpath to successfully complete on. The market has priced in rates at just over 3% for the start of next year, so 2% higher than where we now sit in little under seven months. Maybe this economic cycle is being cut short by the Fed which will be hoisted by its own petard, as they say. Engineering a soft landing with inflation where it is at multi-decade highs and unemployment where it is at cyclical lows is a very difficult task and arguably one it has never achieved before. Recession risks have to be rising therefore.
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