The Fed is willing to inflict pain on the economy to bring down inflation; Stocks, Bitcoin to see more downside – Alfonso Peccatiello

The Fed will “inflict pain” to bring inflation down to 2 percent, said Alfonso Peccatiello, author of The Macro Compass. The resulting central bank policy will have a negative impact on stocks and cryptocurrencies.

In his Aug. 26 speech in Jackson Hole, Federal Reserve Chair Jerome Powell struck an aggressive tone, saying that reducing inflation “will hurt households and businesses.”

“Those are pretty strong words for a politician,” Peccatiello said. “What he’s saying is that the Fed won’t stop until the job is done. The job means inflation falls to 2 percent.”

Peccatiello added that the impact of Fed policy on “risk assets” like stocks and crypto could be devastating.

“[The Fed] needs to keep their monetary policy tight,” he said. “When real returns are high, any investment you make becomes less attractive from a valuation perspective.”

Peccatiello spoke to David Lin, host and producer at Kitco News.

A Fed credibility gap

Powell’s Jackson Hole speech means the Fed is trying to regain credibility after failing to keep inflation around its 2 percent target, Peccatiello said. That means the Fed won’t “pivot” and cut rates until “the job is done.”

US inflation is currently at 8.5 percent in July.

“You don’t regain credibility by moving the goalpost,” he added. “The goal post is 2 percent [inflation].”

Powell previously signaled that he would like real yields to trend higher, making it harder to borrow capital. After Powell’s Jackson Hole speech, five-year real yields, ie nominal yields minus inflation expectations, turned positive.

“We’re talking about almost 1 percent positive real returns in the US,” said Peccatiello. “[Powell] has achieved this goal, which gives it credibility.”

Peccatiello said that Powell will hit his 2 percent inflation target “if he inflicts enough pain on the private sector… The bond market is discounting a reasonable probability of about 35 percent that the Fed’s interest rate will rise to 4 percent.”

Europe’s winter of discontent

As the Fed scrambles to tame inflation, Europe grapples with rising energy prices. Europe’s benchmark electricity price rose tenfold from its decade-long average, and natural gas prices hit €321 ($321) per MWh, compared to €27 ($27) per MWh a year ago.

The reason for this is that Russia has shut down the Nord Stream 1 gas pipeline for maintenance work. Russia supplies 40 percent of the European Union’s natural gas needs.

“About 7 to 10 percent of the [Europe’s] The GDP bill comes from electricity, energy and gas over the winter,” Peccatiello said. “It’s extremely big. We’re talking about costs as high as a banking crisis in Europe… I think in the base case, Europe is unlikely to survive the winter at a very high price.”

He added that in the long run, Europe needs to change its energy model “to ensure it has other sources of energy to continue supplying and producing goods that it can export”.

To see Peccatiello’s outlook for stocks and Bitcoin, watch the video above

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