The markets, in general, seem to be maintaining an optimistic mood regarding the current state of affairs, most specifically as it relates to central bank policy, but I have to wonder if Powell is still covering up some of the riskier details. He did try to temper expectations somewhat by mentioning a more gradual pace of rate cuts moving forward, but he also ensured the markets that the economy was in solid shape. Regardless, the market is still pricing in a Fed Funds rate of around 3% by the end of 2025, which would on the surface seem to be a rather aggressive pace of rate cuts given where GDP growth and inflation are still at.
As of the end of August, the core inflation rate stood at 3.2%, while the core PCE rate was 2.7%. Those numbers are still well above the Fed’s target and they aren’t trending down. I suspect that the Fed is eager to lower rates due to challenging credit conditions and a weaker labor market, but doesn’t necessarily say the truthful part out loud because he doesn’t want to spook the equity markets. He’s said in recent months that the jobs market is now the priority over inflation, but I think he’s playing a very risky game that could allow for a second wave of inflation.
Consider the current risks facing the global economy. We’ve got port workers on strike in the United States, which threatens to jam up the supply chains and have an inflationary effect on goods. We’ve got heightened geopolitical risks in the Middle East with the Israel/Gaza conflict, Israel starting to launch attacks on Lebanon and Iran striking Israel. Crude oil prices have shot higher, which, of course, is also inflationary.
While those may be short-term issues that have a higher likelihood of resolving themselves, we shouldn’t ignore the global liquidity bomb. The Fed is currently on schedule to add potentially hundreds of billions of dollars in liquidity in just the 4th quarter. That would be on top of the billions of dollars of liquidity and stimulus the PBoC just announced in the past week or so. Liquidity, of course, is also inflationary.
It feels like we’re headed into an environment that’s potentially very destructive.
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