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A 4% fed funds rate is on traders’ radars for 2022. But it could be up to two years before the increases have a major impact on inflation.

By Vivien Lou Chen

Financial markets in the US remain heavily focused on the prospect of further interest rate hikes, with traders citing over a 50% chance of the Federal Reserve’s key interest rate target hitting a 15-year high of 3.75%. and 4% by December. But now a branch of the US Federal Reserve is flipping the probability that rate hikes might not have an obvious big impact on inflation for about 1.5 to 2 years, as economists like the famous Milton Friedman have demonstrated time and time again.

In a Wednesday blog titled “Lessons from the Past: Can the 1970s Help Informing the Future Path of Monetary Policy?” — Atlanta Fed economists Federico Mandelman and Brent Meyer offer traders and investors leaning towards a more hawkish US Federal Reserve looking to adjust, insights Conviction on Wednesday, last trading day in August: US stocks were lower in afternoon trade while Treasury yields were little changed as investors await the release of new nonfarm payrolls data on Friday an August Surprise “People tend to keep their money closer to their vests in these times of uncertainty and it’s almost everyone’s guess what happens” when it comes to inflation, the direction of the economy and the level of interest rates, he said Chief Dealer John Farawell at Roosevelt & Cross, a bond underwriter in New York. “Historically, September is not such a great month for equity markets,” and there could be weakness next month for both stocks and bonds to return to normal,” Farawell said by phone on Wednesday.

The problem is that nobody knows exactly how long it will take for inflation to return to the Fed’s 2% target. The Atlanta Fed blog adds to doubts that rate hikes will soon be able to temper sustained gains. The idea of ​​a monetary policy delay is well known in business circles, but has been less part of the broader public narrative about inflation.

In particular, Mandelman and Meyer cited a 1971 speech by Nobel laureate Friedman to the American Economic Association, which coined the phrase “long and variable lags” to describe the lagged effect of Fed interest rate movements on the economy. The main thesis of Friedman’s pronouncements half a century ago “still rings true,” they said. “Changes in monetary policy have the greatest impact first on output and then, much later, on inflation.” “This context is particularly useful for policymakers to consider as they navigate the economic challenges posed by the pandemic,” the Atlanta Fed economists wrote. They also note that in the 1970s, changes in the money supply were the Fed’s primary tool, and the interest rate “played only a minor role.”

For much of the past year, many economists and investors have routinely dismissed the notion that 1970s-style stagflation was developing in the US, even as inflation rates spiked or stayed high and the economy showed signs of slowing. But it’s not just the US that’s struggling: Eurozone inflation also hit a record 9.1% yoy in August in August, and the deepening energy crisis in Europe adds to further concerns. Financial markets tend to be quick to seek results, cheering the fall in annual headline US consumer price inflation to 8.5% in July from 9.1% in the previous month, only to reiterate that the central bank, despite the Pain for households and companies that want to fight inflation. In his well-received speech at Jackson Hole last Friday, Powell also cited lessons from the 1970s. Wednesday’s Atlanta Fed investigation, which creates the GDPNow forecast model and is led by President Raphael Bostic, increases the likelihood that there are no quick fixes; In theory, this would tend to support continued volatility in financial markets. They cited the Fed’s tendency in the 1970s to tighten monetary policy and rapidly reverse course as a recurring theme that “never let inflation fall back to the 1 to 3 percent range that was the norm after the end of the Korean War.” was”. Consequently, the expectation that inflation would not take a back seat eventually became embedded in the American psyche,” the Atlanta Fed economists wrote. “People who had that experience simply expected higher future inflation rates, with that expectation embedded in their pricing and wage-bargaining decisions.” In the days after Powell’s Jackson Hole speech on Friday, Steve Hanke, a professor of applied economics at Johns Hopkins University, told CNBC he believes inflation is rising because of “unprecedented growth “The money supply will remain high and the US is headed for a “whopper” recession next year, if not necessarily because of higher interest rates. And on Wednesday, Cleveland Fed Chair Loretta Mester added her support for raising interest rates from the current one 2.25% to over 4% to 2.5% and said it expects no interest nk next year. What happens to financial markets and the U.S. economy if or when the Fed’s interest rate target rises to 4% “depends on where inflation is at that point,” said Michael Landsberg, Landsberg Bennett Private’s chief investment officer Based in Punta Gorda, Fla. Wealth Management, which manages $1 billion in assets. “If inflation is 7% and the fed funds rate is 4%, that’s not good for markets as more rate hikes are to come,” he wrote in an email to MarketWatch. “If inflation goes down towards the fed funds rate, I don’t think it would be that bad. I think we’re going to have a recession and I don’t think that’s built into the market right now.” “There’s still a lot of misplaced optimism that the Fed will start cutting rates next year because the Inflation will be under control,” Landsberg said. But “inflation in the US will be more stubborn than many realize, and in Europe it’s downright uncomfortable (and still rising).”

-Vivien Lou Chen

(ENDS) Dow Jones Newswires

8/31/22 1411ET

Copyright (c) 2022 Dow Jones & Company, Inc.

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