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With inflation now running at highs not seen since the 1980s, we’ve entered a period where the Federal Reserve is being forced to undertake serious measures to curtail inflation, despite what such measures might do to push the economy into a recession. The Fed’s latest move was to raise interest rates by 0.75% for the second time in as many months, the highest increase since 1994. Yet the move was widely expected by experts and also reflected in numerous investor sentiment surveys, including one conducted by Mitre Media, publisher of MutualFunds.com and Dividend.com (more below).
The question is, when will the pace and size of the Fed’s interest rate moves start to moderate in an attempt at a soft landing?
The Bureau of Labor Statistics’ latest print of the Consumer Price Index (CPI) showed a 9.1% year-over-year increase for June – higher than the 8.6% jump recorded in May and represents a 40-year high. The reasons for the surge in prices are vast, but can be summed up to excess capital in the system and continued problems to the global supply chain.
With elevated prices now posing a real threat to demand and to the economy, the Fed was forced to act. It started by ending its quantitative easing programs, stopping the buying of bonds and ETFs. It also began to ratchet up interest rates. Starting in March, Fed officials raised benchmark rates by 0.25%. This was followed by a 0.5% raise in May and a 0.75% increase in June.
Then in July, the Fed enacted additional measures to stop inflation. This time it was another 0.75% increase to the benchmark rate to the range of 2.25%-2.5%. This pace of rate hikes hasn’t been seen since former Fed Chair Paul Volcker’s attempt to cool inflation during the 1980s.
Despite the unprecedented move by the Fed, the rate hike had largely been expected by investors. Leading up to the FOMC announcement and decision, the Chicago Mercantile Exchange’s CME FedWatch Too – which provides real-time rate expectation results – predicted a 76.3% likelihood of a 0.75 increase.
These results were in-line with a survey conducted by Mitre Media, publisher of MutualFunds.com, MunicipalBonds.com, and Dividend.com. Out of nearly 500 valid responses from advisors, institutional investors and individual investors, about half of those surveyed (54% of advisors, 45% of individual investors) estimated that the Fed would raise by 0.75%. Nearly 45% of the surveyed advisors managed assets of at least $25 million, highlighting a credible viewpoint echoed by investors across the board.
There was plenty of basis for investors’ prediction of a 0.75% hike.The latest FOMC meeting minutes released in June showed that several Fed officials, including St. Louis Fed President James Bullard and Fed official Christopher Waller, were supportive of a larger hike now and smaller hikes as the year goes on. There was even talk from some Fed officials of a full 1% hike in July.
With the 0.75% July hike now set in stone, the question is will it be enough and what comes next? The answer may not be so easy to predict.
The global supply chain, which was rocked by the pandemic, is improving, but it’s still a factor. High energy prices are another major factor. The war between Russia and Ukraine has created a situation where more countries are chasing a single barrel of crude oil, contributing to price inflation. The latest CPI report showed that energy prices surged by more than 40%. This has a trickle-down effect on a variety of goods as it now takes more to make, grow, and ship them.
The situation leaves the Fed with little room to maneuver and it might be that raising rates high enough that the economy starts contracting is the only way to beat inflation. This is an idea that Fed chairman Powell seemed to acknowledge in recent remarks: “We actually think we need a period of growth below potential in order to create some slack.”
The contraction (or “growth below potential”) may already be happening, with preliminary Q2 GDP figures indicating the U.S. economy contracted by 0.9% on an annual basis. This would mark the second consecutive quarter of shrinking GDP and meet the generally accepted definition of a recession.
With inflation running stubbornly high, the Fed has been forced to take unprecedented action and raise rates by 0.75% for the second straight month. The question is whether or not the various supply chain woes and energy issues can be resolved soon and if the Fed’s current aggressive approach needs to start to moderate in order to manage a soft landing for the economy. Watch this space for more. We will be conducting more investor surveys to get your take.