LAWRIE WILLIAMS: Fedwatch now strongly predicting 75 basis point rate rise
We have expressed the opinion here that one can best assess the mood of the U.S. markets with respect to the likely moves to be undertaken by the country’s central banks at the next Federal Open Market Committee (FOMC) meeting – now just under two weeks away – by movements in the Chicago Mercantile Exchange’s Fedwatch Tool. This has been pretty volatile and has mostly moved between about 60:40 in favour of a higher 75 basis point (3/4%) rate increase being imposed at the meeting as against a 50 basis point one up to an 82:18 likelihood yesterday – the highest we have seen so far, although fell back to 78:22 overnight. Indeed some commentators have even been predicting that the Fed might raise rates by a full 1% at the event – a rise that would almost certainly lead to absolute market mayhem.
The markets are fickle though. We are due a set of Consumer Price Index (CPI) data next week which could well be seen as suggesting that inflation may at last be beginning to slow down. If this happens, expect the Fedwatch Tool ratio to come back down sharply.
There have been signs that the two biggest inflationary components, energy and food price rises, may be at least moderating a little and market optimists may well seize on this to mitigate their forecasts, but this may well just be wishful thinking. Core inflation levels will likely still remain elevated and are likely to remain so for some time to come.
The Fed is thus unlikely to deviate from its aggressive interest rate-raising and belt-tightening course and looks to be on track to raise federal funds rates to between 375 and 400 basis points by the year end. Even this elevated level seems unlikely to have any serious effect in bringing inflation down to anywhere near the Fed’s expressed target rate of 2% though.
What all this will do is almost certainly precipitate a mini-recession at the very least. Businesses have become used to operating in a plentiful monetary, low interest rate environment conducive to expansion. If this is all withdrawn rapidly they will find themselves overstretched, particularly if consumer spending begins to fall away concurrently, with rising prices eating into disposable income. Profits and stock market valuations will begin to fall and this could all turn into a downwards spiral which, if it starts could be difficult to bring under control. This could well be the 1930s all over again.
The consolation is that the world survived all that, but not without a global war in between and modern weaponry is such that human survival of another such conflict has to be far from certain. The battle lines in terms of rhetoric certainly seem to be being drawn. Let’s hope that wisdom prevails and we pull back from the brink!
Meanwhile markets were mixed yesterday. The gold price sank. But then recovered and moved comfortably back into positive territory, while silver was looking much stronger too. Equities started lower, but then made a strong recovery as did bitcoin, while the dollar indexes came down a little, although the DXY remained above 110, helped by weak European markets mostly suffering from issues with Russian energy supplies. Equity and bitcoin strength is, in our view, a dangerous path to follow – certainly if the Fed embarks on the anticipated higher interest rate pattern at future FOMC meetings.