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U.S. stocks closed up 6.91%1 for the week on a growing sense that the Fed’s aggressive rate hikes may be beginning to have an impact on inflation, potentially reducing the need for steeper rate hikes in the future. Market inflation expectations for 1-, 3-, and 5-years from now all declined slightly this week,2 helping fuel the rise in stock prices. And there’s some evidence to support this optimism: while headline inflation continued to rise last month, propelled mostly by increases in food and energy, a closer examination of inflation data over the past 12 months suggests that core inflation may have peaked back in March (see Exhibit A).
Over the past six weeks, the Federal Reserve unleashed a significant amount of anti-inflationary firepower on the economy: a 50-basis point rate hike in early May, followed by a sharp 75-basis point rate hike just last week. Additionally, this month marks the beginning of the Fed’s new “quantitative tightening” strategy, an anti-inflationary policy whereby the Fed allows bonds on its balance sheet to mature without subsequently reinvesting the proceeds in new bonds. Whether these actions ultimately begin to temper in inflation remains to be seen but what is now unequivocally clear to markets is the Fed’s commitment to bringing it under control.
What’s less clear, however, is the near-term future of the global economy. Many, if not most, of the root causes of today’s inflation have their roots far from our shores and beyond the influence of the Fed: the war in Ukraine, disrupted global supply chains, limited refinery capacity, and covid-shutdowns in China to name only a few. Subsequently, the Fed’s ability to combat the inflationary impacts of those challenges is unclear at best; what is clear, however, is that the Fed’s actions will have a negative impact on economic growth and may, perhaps, tip the U.S. economy into recession, if only a mild one.
Exhibit A: 12-month percent change in CPI for All Urban Consumers (CPI-U), not seasonally adjusted, May 2021-May 2022.3
1 Russell 3000 Index
2 Source: YCharts, Inc.
3 News Release, US Bureau of Labor Statistics, June 10, 2022.
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