Too Dovish, Too Hawkish

A "very tight" labor market and unchecked inflation could force the Federal Reserve to raise interest rates sooner than expected and begin decreasing its overall asset holdings as a second economic brake, policymakers at the US central bank said last month.

The minutes from the Fed's Dec. 14-15 policy meeting, which were released on Wednesday and interpreted by markets as decisively hawkish, showed Fed officials evenly concerned about the rate of price increases, which were expected to continue "well into" 2022, as well as global supply bottlenecks.

"Participants noted that supply chain bottlenecks and labor shortages continued to limit businesses’ ability to meet strong demand. They judged that these challenges would likely last longer and be more widespread than previously thought." Minutes of the Federal Open Market Committee December 14–15, 2021

Additional Rates Increases

According to CME Group's FedWatch program, the possibility that the Fed would raise interest rates in March for the first time since the epidemic began has risen to more over 70%.

This and the threat of the Fed withdrawing from long-term asset markets, pushed the 10-year Treasury yield to its highest level since April 2021.

"Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate." Minutes of the Federal Open Market Committee December 14–15, 2021

BENCHMARK'S TAKE

After a relatively large miscalculation of inflation, supply chain bottlenecks and labour shortages, the Fed is now trying to work back against some of its mistakes. Yet, this time, many investors fear that the Fed might act too strongly and push the economy into a recession.

  • Since the start of the pandemic, the Fed has often overestimated its powers, by believing it can be an actor of social change all while maximising employment and minimising inflation
  • Its first intention of engineering a broad and inclusive post-pandemic recovery led to inflation rates not seen in decades
  • The Fed is now believing that it can solve supply chain bottlenecks and labour shortages by using its monetary policy as a weapon
  • After being too dovish for months, we believe the Fed is racing towards a second mistake by being too hawkish and may put the recovery at risk by increasing rates while it most probably will fail to contain inflation
  • We believe the Fed should be more cautious in its approach and focus on providing a stable environment businesses can trust rather than rushing to solve all of a nation's problems on its own
  • Yet, we believe the Fed won't back down and push ahead with its hawkish rhetoric. We thus expect growth stocks to endure a weak environment going forward while highly profitable businesses trading a reasonable valuation may fare better

Disclaimer

Please note that this article does not constitute investment advice in any form. This article is not a research report and is not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

Credits

Photo by Floriane Vita on Unsplash.