The Fed Continues To Focus On Inflation
Inflation data continues to run hot. We saw an increase in market volatility after the recent release of May's CPI data. The S&P 500 Index officially moved to a bear market last week.
In response to persistent inflation, The Fed increased its benchmark rate in June to a target range of 1.5 – 1.75% by making a 75 basis point increase - the first 0.75% move since November 1994. The new set of economic projections and Fed Chair Powell’s press conference all highlighted a Fed emphatic about getting inflation under control.
The Fed’s is trying to control inflation by keeping long-term expectations anchored. Even though the increase was dramatic, the fed funds rate is still below what is generally considered neutral, estimated at roughly 2.5%.
"...There’s not an easy fit between what the Fed may have to do to bring down inflation and the soft landing they’re trying to achieve. The choices are going to get harder over the second half of the year,” said LPL Financial Asset Allocation Strategist, Barry Gilbert.
Here are three observations in response to the recent rate hike:
- Raising rates helps control inflation by lowering demand. The Fed’s main fight right now is against long-term inflation expectations. Once expectations go up, they are hard to bring back down. That’s part of why the Fed thought the 0.75% hike was important.
- There is a point for rates where the economy breaks. The Fed is trying to slow growth so that demand comes back down without actually pushing the economy into recession. The Fed doesn't exactly know where that breaking point is, therefore they likely will continue hiking rates at a gradual pace vs. implementing all the rate hikes at once. We expect the Fed to hike rates again during their next meeting in July. The market is currently pricing in another 0.75% hike.
- Inflation has been the weak spot on the economy and has been stressed repeatedly with supply chain disruptions, excess stimulus due to a surprisingly robust recovery and a tight labor market with many workers leaving the labor force. On top of everything else, commodity prices have increased due to the war in Ukraine. If supply chains improve, we could see inflationary pressure ease. The question is whether improvements will happen fast enough.
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All index data from FactSet and MarketWatch.
This Research material was prepared by LPL Financial, LLC.