Rates Going Higher

There are clearly signs of stress. Most Americans are feeling squeezed by inflation, especially higher prices for gasoline and food. Homebuilders are pessimistic due to both higher inflation and higher interest rates.

The Fed has embarked on a campaign to tighten monetary policy that is spooking the equity markets. In early May the Fed Open Market Committee hiked the fed funds rate by 50 basis points and two additional 50 basis points and two additional 50 basis points hike are virtually guaranteed on June 15 and July 27 if not higher. The interest question now is what is the Fed going to do in September, November and December?

Vice Chair Lael Brainard said last week that “it’s very to see the case” for the Fed pausing their interest rate hikes. But does everyone remember one of the Fed’s favorite phrases, “data dependent?” There may not necessarily be a pause in hikes later this year, but it's certainly possible that there will be a reduction to 25 points, a slowing.

What data points would cause this to happen? Most likely solid signs that inflation has peaked and is retreating would help. Unfortunately, the May Consumer price index that came out on Friday did not showing a peaking of inflation.

Many market watchers and media types are forecasting stagflation…. A recession mixed with high inflation. That’s a double-whammy that would certainly continue 2022 stock market declines. But there is a community of economists who see the US economy growing through 2024 (albeit more slowly) as inflation slides back toward the Fed’s 2% target. For example, all 56

economists who provide quarterly forecasts to Bloomberg see growth over the next seven consecutive quarters.

These economists put the probability of a recession at about 30% at this time. That’s not insignificant, but it is also not a historical outlier.

Another underlying factor according to Boston College economics professor Brian Bethune is that the US economy entered the pandemic with no discernable imbalances. Remember the housing bubble? Unlike the Great Recession (2007-2009), banks, businesses, and individuals were not exposed to excess risk in 2020.That allowed the economy to snap back from the Covid closures and temporary unemployment