Home Interest rate The inflationary shock in the United States is a bad sign for interest rates

The inflationary shock in the United States is a bad sign for interest rates

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It is now expected that when the Fed’s open market committee meets next week it will hike the fed funds rate by 75 basis points, its third outsized move in a row, the odds of a ultra-aggressive 100 basis point hike increasing to more than one in three.

There is a strong argument for this larger move and for further (perhaps not as large) increases at the remaining committee meetings in November and December. The Fed needs to get ahead of expectations and drastically reduce consumer and investor confidence — and likely economic growth in the process — if it wants to lower the rate of inflation. It will also likely have to continue raising rates faster and further than it itself would have considered.

The RBA has raised official interest rates for a record five consecutive months.Credit:Louie Douvis

Where market participants have seen rates peak late this year or early next year around 4%, it now looks likely that this peak will occur well into next year and solidly at above 4%, although this is, of course, a volatile environment. .

The data, clearly, was not good news for stock or bond investors in what has been a horrific year so far for investors.

The US stock market is down about 18% this year and bond market investors are experiencing their first bear market in decades. Hardest hit have been investors in tech and other high-earning multiple stocks, with the tech-laden Nasdaq index down 5.2% in response to inflation figures and now down 27% from its peak at the end of last year.

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The data, and the Fed’s likely response, also bode ill for markets and economies outside the United States, given that Fed Chairman Jerome Powell has made it clear that the Fed will be guided by the data and do whatever it takes to bring inflation under control.

Not only does the US Treasury market serve as a benchmark for all other bond markets, but rate differentials between the US and other economies drive currency movements.

While the Fed has acted faster and stronger than other major banks this year, the US dollar has strengthened by almost 15% against the basket of currencies of its major trading partners. If they want to avoid destabilizing capital outflows and a depreciation of their own currency (and a corresponding rise in inflation), other central banks are under increasing pressure to emulate the Fed.

The strengthening dollar has particularly unpleasant effects on economies that need to import commodities (most of which are denominated in US dollars) and that have high levels of US dollar-denominated debt.

These are usually the emerging market economies, although the energy crisis in Europe and Europe’s mad rush to secure supply at all costs to replace the gas that was coming from Russia means that the eurozone, too, will now be under even greater pressure.

The Fed is struggling to contain US inflation.

The Fed is struggling to contain US inflation. Credit:PA

While the European Central Bank recently raised its key rate by a record 75 basis points, to 1.25%, the ECB is far behind where the Fed is today let alone where it could be next week. and is in the awkward position of knowing that it must raise rates to kill soaring Eurozone inflation rates and avoid being crushed by dollar strength even as the zone heads almost inexorably towards the recession.

The Reserve Bank does not face the challenges of the ECB, but it has always been very aware of the implications of Fed decisions on the value of the Australian dollar and the flow effects of currency weakness on inflation and the growth.

The only bright spots in macro metrics are oil price falls – the price is now below US$94 a barrel after peaking earlier in the year near US$130 a barrel and OPEC is cutting rather than increases supply – and a sign that the disruptions in global supply chains that have plagued the global economy and played a major role in the burst of global inflation are gradually waning.

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These bright spots, however, only underscore how difficult and stubborn the current high inflation environment is and make it more likely than not that central banks will be forced into much more aggressive action than themselves, or those on the market, weren’t even planning in the days leading up to the latest release.

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