Central Bank Hawkishness Hasn’t Faded Yet Despite Lower Inflation

Inflation may be coming down from 9% (zero percent in July, as noted by President Biden), but the Fed and most other Western central banks are not done hiking interest rates.

Markets are up again today and have reversed their bear-market trend because big investors are betting that a recession will stop the Fed from raising rates this fall. They’re trying to get ahead of that news.

July’s flat month-over-month consumer price inflation supported that view even as 12-month inflation is still over 8.2%. Optimism for more cheap capital is starting to wane, UBS analysts led by CIO Mark Haefele said in a client note on Thursday.

The Fed’s July meeting minutes showed that top officials expect restrictive monetary policy to be necessary “for some time” to cool inflation, UBS analysts said. “With the Fed in data-dependent mode, it is too early to look for a pivot in policy. The Fed Open Markets Committee (FOMC) meeting minutes show no signs of a pause,” they wrote.

UBS said the FOMC minutes “did not contain any major surprises” either — which they interpreted to mean the U.S. central bank is still hawkish.

Markets on Thursday don’t look worried. Even Turkey lowered interest rates despite Venezuela-style inflation of a whopping 80%.

“Unfortunately, there was virtually nothing in those minutes to substantiate the case for lower rates,” says Vladimir Signorelli, head of macro research firm Bretton Woods Research (BWR). He agrees with UBS that Fed consensus remains hawkish and that returning inflation to 2% is believed to be “critical to reaching maximum employment.”

Getting to 2% means higher rates, which means a definite recession beyond the already technical recession reached in 2Q. Meaning: job losses.

Main takeaways from the minutes, per BWR:

  1. The Fed believes a “restrictive stance” is necessary to meet its dual mandate;
  2. More rate hikes are coming, but at some point the pace will slow;
  3. It is appropriate to maintain a restrictive policy stance “for some time;”
  4. Expects unemployment to rise for the rest of the year.

“Nowhere in recent FOMC minutes or open mouth communications do we see a concrete path emerging for lower rates by year-end,” Signorelli says.

Look for the Fed to gloss over lower oil and gasoline prices unless they totally collapse (say, gasoline at $2.80). The minutes state that “declines in the prices of oil and some other commodities could not be relied on as providing a basis for sustained lower inflation…there was little evidence to date that inflation pressures were subsiding.”

“Inflation Reduction Act” Won’t Help

The newly signed Inflation Reduction Act will not lower inflation.

The law, packed with incentives for clean energy companies, first dibs on certain government loans for farms that promise to lower methane and reduce nitrogen fertilizer use, and a Medicare provision that might reduce drug costs starting only in 2026, should have been named the ESG Law. That’s short for the Western world’s new favorite investment theme: Environmental, Social and Governance.

Even the pro-Biden Washington Post admits the law does not really tackle inflation in an article published on Tuesday, the day the bill was signed into law.

If it does cut inflation, at least one third-party forecast is estimating a 0.1 percentage point cut in about five years, according to an analysis by the University of Pennsylvania’s Penn Wharton Budget Model.

The Fed funds futures market is showing that investors think an additional seven basis points of tightening will happen between now and April 2023. Barring more surprising supply chain crises, food crises, energy crises, and other crises, that should be the end of it before the Fed starts to cut.

Earlier this month, the Bank of England (BoE) raised its benchmark interest rate to 1.75%. The BoE predicted the economy would enter a recession soon, even with the rates still at historic lows. UK inflation is currently sitting at a ridiculous 10.1%, a 40-year record.

And on Thursday, not to be outdone and always ready to shoot self in the foot, a European Central Bank (ECB) board member said more rate hikes were coming. The ECB surprised investors with a 50-basis-point rate hike last month, fearing that record-high inflation — caused by Europe’s Russian fuel sanctions and new climate change policies targeting farming, more recently — was at risk of getting “entrenched”, Reuters reported today.

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