. While the tug-of-war was apparent before last Friday, with some market participants anticipating a policy pivot from the Fed while others were looking for continued hawkish drive to address inflation, the head of the US Central Bank made clear that the focus and priority was on addressing inflation., highlighting the fact that it seems that the Fed can’t really afford to miss the mark here.
Inflation can create massive problems and historically speaking, we’re already at far-elevated levels. The most recent example of inflation in this range was in the late-70’s, the era of stagflation. The Fed continued to hike but inflation only continued to rise, and at the source of the problem was an unwillingness of theChair at the time, Arthur Burns, to risk a hit to growth by hiking too much. So the problem only continued to build.
But – to do that Volcker had to hike rates even above inflation. In 1980, CPI was at 13.5%. But Fed Funds was at a whopping 20%! Within two years, inflation had come down and by 1983 CPI was back-below 3%. The problem is that the US debt-to-GDP ratio is at 137.5% and when Volcker made his move, it was sub-40%. So the US carries much more debt today than it did then, and debt service on such a massive amount of debt makes Volcker’s gambit seem less possible today than it did then.
So, the Fed really wants to get inflation down here because the consequences could be sizable and not simple to address. And this can continue to act as a pressure point for stocks as the Fed is still uncertain of how high they’ll need to hike to actually get inflation to more tolerable levels.
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