To The Moon

Today marks the start of the US Fed meeting. I wrote some final thoughts in the form of three “St”: (Note: I am not a Straits Times writer😊):

• Sticky Inflation
• Strategic Ambiguity
• Status Quo

Sticky Inflation

I have written that inflation is sticky and has been surging uncontrollably. See more details on sticky inflation:

Talking Points: Sticky Inflation

Strategic Ambiguity

Today, I read an article that US President Joe Biden has veered from US policy of “strategic ambiguity” towards Taiwan. Now, the US will defend Taiwan from any military invasion. This is a change from the longstanding policy stance where the US does not make clear whether it will militarily defend Taiwan.

I postulate that the US Fed is also engaged in a policy of “strategic ambiguity” towards inflation. Last year, Fed Chair Powell regarded inflation as “transitory”, even though it is obvious the inflation could get out of hand as US exits from the COVID pandemic. With massive monetary and fiscal stimulus pumped into the US economy, it is a no-brainer that inflation could surge uncontrollably instead of being transitory.

As a result, the Fed is behind the curve when it comes to inflation and was slow in hiking interest rates. Now, he is facing a tough choice as inflation is now running super-hot at 8% to 9% handles. This is far above its 2% inflation target.

Before we can blame Powell further, we must note that is reasonable for him to engage in “strategic ambiguity”. This is because it is politically inappropriate for Fed to be hawkish. No one wants to be blamed for slowing the economy or crashing the stock market. We all loved to ride on the bull market forever, regardless of whether it is sustainable or not.

Now, when Powell switched to “strategic clarity” on fighting inflation, he is faced with strong pressure from the politicians. He recently warned that there could be more economic pain from sharply higher interest rates, with a possible hard landing in the US economy. This has resulted in pushback from US politicians, including Senator Elizabeth Warren. Senator Warren warned that “Jerome Powell’s rhetoric is dangerous, and a Fed-manufactured recession is not inevitable — it’s a policy choice.” The lawmakers further criticized that policies by US Fed could lead to millions of job losses.

Status Quo or not

This brings me to my final point.

In the September meeting, the US Fed is widely expected to hike interest rate by 75 bps, bringing the upper bound Fed Funds rate to 3.25%. This is the status quo position.

But, the US Fed is really in a tough position. It is caught between a rock and a hard place.

Fundamentally, inflation is too high. It is also broad-based and sticky. The gap between inflation and Fed Funds rate is just too wide. A 100bps hike will only put the upper bound Fed Funds rate at 3.5%, leaving a shortfall of 4.8%. In another words, the Fed Funds rate should be at least 7%, instead of 3.5%.

So, it could be better for US Fed to engage in “strategic clarity” towards fighting inflation. Be relentless in adopting a hawkish stance, and possibly hike 100 bps in the September meeting. Such Volcker-esque signal could be needed to signal that the Fed is doing whatever it takes to fight inflation.

Or, the US Fed could remain in status quo and engaged in “strategic ambiguity” towards fighting inflation. This will be a politically popular move as the US mid-term elections is approaching in November this year. Powell could listen to the criticism from US lawmakers and take lukewarm steps in fighting inflation.

This is similar to the policies of US Fed President Arthur Burns in the 1970s where small rate hikes were taken to fight inflation. This has resulted in inflation to rise uncontrollably. It was only when US Fed President Paul Volcker was in charge, then interest rates were raised high enough for inflation to be finally broken.

In short, the US Fed is faced with a tough choice: to choose status quo of a 75 bps rate hike, or go against market expectations and raise interest rate by 100 bps to control inflation.