The inflation genie is fully out of the lamp we now need to prepare for how it might get put back in. There is crass joke in markets – How do you kill inflation? The answer of course is a recession.
That was highlighted by Jay Powell’s testimony at his bi-annual meeting with the Senate Financial Committee. Just a reminder that the US mid-term are in November and considering the state of play in the State both side of politics want to hang this problem on the Fed.
These two quotes sum up the mood perfectly: Senator Elizabeth Warren (D): “You know what’s worse than high inflation and low unemployment is high inflation and a recession with millions of people out of work, and I hope you’ll reconsider that before you drive the economy off a cliff.”
Senator John Kennedy (R): “Inflation’s hitting my people so hard they’re coughing up bones.”
In fact this was Powell’s response to Warren’s comments: “It’s certainly a possibility…It’s not our intended outcome at all, but it’s certainly a possibility, and frankly the events of the last few months around the world have made it more difficult for us to achieve what we want, which is 2% inflation and still a strong labour market.” That is one way to put the inflation genie back in the bottle. The follow-on discussion can be summarised with this, “rates will have to rise until there is ‘compelling evidence’ that inflation is coming down.’
“At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so…We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses.”
That resolve can be seen in one of the biggest Doves on the board before this all started in San Francisco Fed president Mary Daly stating that a 75 basis point (bps) hike in July is needed to get too neutral as quickly as possible. She gave herself some wiggle room suggesting a 50bp could be warranted if the economy slows more than expected.
Her view is that in the currently climate neutral is around 3.1%, when inflation is stable at 2% the neutral rate is 2.5% when inflation is stable around 2%. So buckle up – tightening is only just beginning. All this has the USD remaining in the ascendency
EUR/USD has fallen back to $1.0555, GBP/USD to $1.2270. USD/JPY remains at two-decade highs around ¥135.15. AUD/USD is still sub 70cents at $0.6940.
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