Last week’s action gave traders another case of whiplash. The markets rose sharply following the midterm elections. In fact, the 60-point move up in the SPX 500 on Wednesday was the ninth best ever. On Thursday, the Fed passed on a rate hike, issued a hawkish statement and seemed to hint at inflation worries.
Do we need to be worried as well?
The markets were hammered on Thursday and Friday, but it actually had nothing to do with the the Fed. History has shown that big up moves are lost every time within days or weeks, so a pullback within a continued downtrend was not a surprise.
Another rate hike in December (the ninth since 2015) would not be a surprise either. However, it appears inflation expectations are rising and that concerns the committee.
Inflation worries ahead
Friday’s Producer Price Index (PPI) number was alarmingly high, annualized at 7.2%. That is well above what is acceptable to the Fed, so they may have to not only hike faster but higher than planned. One number does not a trend make. We’ll wait to see how the PPI looks over the next month or two. In next month’s jobs report, we’ll get additional information from the Consumer Price Index (CPI) and wage growth numbers.
The Fed has been trying (willing?) to allow some inflation to come into the system for years. A strengthening employment market and economy slowly delivered. As a result, inflation expectations have been anchored but modestly rising. The Fed’s tolerance seems to hover around 2-2.5% annual inflation. Above that, inflation worries kick in and red flags will fly.
You may have heard the Fed talk about a symmetrical inflation target. If the numbers point to inflation that is too high or too low, the Fed will respond. Yes, the expectation of higher inflation is going to be a concern. They will use all tools at their disposal to snuff out inflation if it appears out of control.
Note that on Friday, the hotter than expected PPI knocked stocks around, but bonds moved higher. Perhaps the bond market will embrace an aggressive Fed? Time will tell.