Inflationary Expectations Could Embolden The Fed To Hike Rates
The big question facing financial markets now is, “What will the Fed do?” Fed Chairwoman Janet Yellen previously intimated her desire to unwind the effects of quantitative easing (“QE”). That process appears to be underway, albeit very slowly. New Fed Chairman Jerome Powell has intimated he will go ahead with gradual rate hikes despite volatility in the financial markets:
Federal Reserve Chairman Jerome Powell suggested that the U.S. central bank would push ahead with gradual interest-rate increases even as it remains on the lookout for threats to the financial system in the wake of the recent stock market rout.
“We are in the process of gradually normalizing both interest rate policy and our balance sheet,” he said Tuesday in the text of his ceremonial swearing-in speech in Washington, adding, “We will remain alert to any developing risks to financial stability.”
There are fears that the Fed could get behind the curve if it waits too long to raise rates. I am of the belief that the Fed should normalize interest rates in order to see what the true state of the U.S. economy truly is. If the economy falters then we know prior stimulus might have been ineffective, and we need to try new methods. Secondly, this presents an opportunity for Powell to define the Fed’s mandate under his regime. Should it fight inflation like former Fed Chairman Paul Volcker vowed to do? Should it stabilize financial markets at all costs? This appeared to be the mandate of global central bankers over the past decade.
Three or four rate hikes might not have an impact on long-term rates. Ultimately, investors have to decide if inflation warrants a sell off in long bonds. However, multiple rate hikes could finally send a signal to the equity markets that the Fed will no longer buttress stocks and encourage risk taking. Such a signal could send financial markets into a deeper tailspin. In my opinion, investors should avoid financial markets until the Fed hikes rates and the dust settles.
