More of the Same Ahead
Updated: Aug 20, 2021
Inflation conversations came to a head June 15-16, when the Federal Open Market Committee met and announced the Fed's new monetary policies. The meeting consisted of 12 individuals — mainly board governors and some representatives from local banks.
The committee target three essential topics during their meeting:
The committee decided to keep the target range for federal funds rate at 0-0.25 % until maximum employment.
Inflation has risen to 2%, and it is on track to moderately exceed 2% for some time.
The Fed will continue to increase its holdings of Treasury securities by at least $80 billion per month and agency mortgage-backed securities by at least $40 billion per month.
Even though we are above the target inflation rate, the graphs below show inflation well above 2% and trending down.
In addition, the Federal Reserve will continue to increase its holdings of Treasury securities and agency mortgage-backed securities until substantial progress has been made toward the committee's maximum employment and price stability goals. These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.
It's also worth noting the dot plots below. Here, you can get a sense of the opinions of the 12 members of the Federal Open Market Committee. They believe the Fed will increase rates in 2023, and the central bank will hike at least twice that year. Only five members still see the Fed staying put through 2023, and seven of the 12 members see the Fed possibly increasing rates as early as 2022.
Indexes of the Market
Let's look back 20 trading days at the different indexes of the market; we see NASDAQ (red), the 7-10 year treasury interest rate, the S&P 500 small-cap, copper, and gold (two bottom lines).
On June 16th, copper, gold, and the S&P 500 small-cap were already trending low, and they sold off going into and after the FOMC meeting.
Inflation at Risk
Inflation is undoubtedly a risk, but we're trying to understand what the market is doing. We're talking about possibly raising interest rates in two years if inflation is still high.
Going back to the beginning of the 21st century, we've been at a zero federal funds rate most of the time.
Federal funds rate
The interest rate banks charge each other to borrow or reserve extra funds overnight.
From 2008-2016, we slowly saw an increase — until 2020, when we went back down to zero. The Fed has historically kept these interest rates low over time, and we don't believe that will change going forward.
So, let's go back to inflation. You might expect inflation to be low over the time we've been at a 0% federal funds rate, but it has not necessarily been low. We see the 16% Trimmed-Mean Consumer Price Index (CPI) as a measure of core inflation calculated by the Federal Reserve Bank of Cleveland. The Trimmed-Mean CPI excludes the CPI components that show the most extreme monthly price changes. This series excludes 8% of the CPI components with the highest and lowest one-month price changes from each tail of the price-change distribution resulting in a 16% Trimmed-Mean Inflation Estimate.
Therefore, inflation is not necessarily shown in the data, and I don't think the Fed will respond by raising interest rates. They've kept rates down to near 0-25 basis points, but the market responds as if this is a hawkish statement.
In conclusion, GWS believes that the inflation risk is undoubtedly high, but we don't see a pause in inflation. Remember, high prices solve high prices, and we have seen commodities pullback before.
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