Yesterday, the BLS released the September CPI Inflation report which showed inflation rose 0.4% in September. The report revealed that the CPI inflation index was 8.2% in September year-on-year (YoY), down 0.1% from the previous month’s 8.3% year-on-year. annual. However, it is the core CPI that has received the most attention. Core CPI in September fell from 6.3% yoy in August to 6.6% yoy in September.
Interest rate hikes have an intrinsic time lag to have a real impact on inflation, and the base level of inflation is the preferred data the Federal Reserve uses to shape its monetary policy. That being said, a slight rise in the level of underlying inflation after the Federal Reserve aggressively raised interest rates from near zero to between 300 and 325 basis points in the past five consecutive meetings from the FOMC this year, which includes three consecutive rate hikes of 75 basis points each in June, July and September clearly show that recent rate hikes have a nominal effect on lowering inflation.
However, they had a dramatic impact on the rise in US debt yields. The 10-year Treasury yield rose above 4% today and, after taking into account today’s 1.68% gain, is currently yielding 4.02%. US 30-year bond yields are not far behind, yielding 3.997%.
The Truth and Implications for Yesterday’s Core CPI Continue to Deteriorate
The simple truth is that inflation shows no signs of abating, raising angst as financial markets increasingly expect the Fed to hike its internal fed funds rate to 5% or more by March next year.
According to the CME’s FedWatch tool, there is a 96.7% chance that the Fed will implement another 75 basis point rate hike in November, and a 66.7% chance that it will raise its rates. rate by another 75 basis points in December, which would bring federal funds rates between 450 and 475 basis points by the end of 2022.
The repercussions of the recent series of extremely large rate hikes will most certainly create extreme volatility and bond, currency, stock and precious metals. The pace at which the Federal Reserve has made up for the key mistake of not raising rates in 2021.
Inflation in 2021 started at 1.4% in January and in December was at 7%, and the Federal Reserve did nothing to reduce inflation until March 2022. It is clear that if the Federal Reserve implemented small rate hikes in 2021, inflation would be far from its current level. The Federal Reserve has painted itself into a corner that has forced its revision of the extremely aggressive rate hikes we are currently experiencing.
According to the vast majority of economists, a federal funds rate of 5% or higher would have a devastating effect on the economy. This would be negative for stocks and earnings and lead to more bond sell-offs. This could essentially prevent lending from individual loans such as mortgages or corporate loans.
More worryingly, some economists expect the fed funds rate to hit 6% at some point. The repercussions could easily exacerbate and accelerate a global recession scenario creating a major disruption to the global economy.
The sad truth is that this scenario could have been avoided had the Federal Reserve acted on rising inflation in 2021. While they were certainly not responsible for the black swan event which was a pandemic leading to a recession, they are fully responsible for not acting in an effective and reasonable time when it was quite evident in 2021 that inflation was starting to spin out of control.
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Wishing you as always good exchanges,
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