The Federal Reserve has finally become much more serious about controlling inflation. Inflation has gotten so hot by any measure, including core CPI, that Jay Powell can no longer keep his head in the sand. His Fed is pulling trillions in liquidity out of the market by reducing the size of its balance sheet and moving the Fed Funds rate up by 75 basis points to a range of 1.50% to 1.75%. And, there is more to come.
Powell now says that the July meeting will involve either a 50 or a 75 basis point increase in the Fed funds rate and that additional rate increases in 2022 will be warranted. The Fed’s own Fed funds forecast now puts the Fed funds rate at 3.40% by the end of 2022 and 3.80% by the end of 2023.
Historically, periods of extreme inflation are not necessarily appropriate times to be in cash. Real assets, like real estate and equities, can perform better as a means to maintain and store value.
This time is different. It is coming on the heals of a decade of Fed-induced real asset price inflation – and a bubble in speculative assets, including crypto – that has become especially exacerbated since the pandemic started in 2020. These bubbles are all going to need to be unwound as the Fed moves aggressively to normalize the economy and to protect it from continuing to be overcome by inflation. Perhaps it can be done without causing a recession (as argued by Ben Bernanke in today's New York Times). But, against the concurrent backdrops of an economy that is now dramatically slowing, Russia extending its war in Europe, an ongoing insurrection in the US, and a global climate crisis becoming a climate catastrophe, we may not see much in the way of other safe real assets that maintain value until valuations are fully reset.
Savings rates and CD rates are rising and these products seem like attractive places to sit for while.
The Federal Reserve has finally begun to act according to its mandate to maintain price stability, but inflation is already running rampant. Today’s move is just the beginning of moves that will be necessary. The Fed’s statement left us with little in the way of guidance in terms of how far and how fast it is going, but Powell’s press conference did not.
Powell addressed the American public by saying that inflation is much too high and supply chain disruptions are being exacerbated by Russia’s invasion of Ukraine and the COVID lockdowns in China. In other words, it is possible that we still haven’t seen peak inflation.
Powell himself seems to believe the Fed is way behind the curve and is going to need to be very hawkish. Whereas economists had previously looked for another 50 basis points move at the conclusion of the June 14-15 meeting, and 25 basis points at each of its four remaining meetings, Powell introduced the possibility that there may be a series of 50 basis point moves through the year. Depositors can expect much higher rates in savings and money market accounts after today’s move and through the year.
You may want to bookmark BestCashCow’s online savings page here. You should also consider savings rates where you live here.
CD rates are also obviously going up. We warned about rushing into CDs last week in this article. Rates have gone up since then with leading 1-year CD rates above 2% and 5-year CD rates now above 3%. CD rates will get more and more tempting, especially when we have not seen anything for cautious investors to even nibble on since the beginning of the pandemic.
Before jumping into a CD, folks need to play around the CME’s Federal Reserve Open Market Committee’s Fedwatch tool here. It demonstrates the probabilities assigned by to different interest rates by economists’ targets at the end of each upcoming Fed meeting. As of this writing, it indicates a 79% probability of a target rate of 3.25% to 3.50% following the December meeting, some seven months from now, and a 92.5% probably that we will be at that level following the July 2023 meeting.
The Federal Reserve has raised interest rates by 25 basis points today, moving the Fed funds target rate off of zero to a target of 0.25/0.50. The target rate had been at zero since COVID-19 arrived on US shores more than two years ago, and was brought there along with extraordinary Fed intervention in an attempt to stimulate financial markets and keep the US from entering a recession or depression.
We’ve had two previous liftoff days in the last twenty years. On June 30, 2004, the Consumer Price Index (CPI) was 3.1%. And, on December 16, 2015, the CPI stood at 0.5%. The fact that the CPI has reached 7.90% before the Fed has acted indicated that Chairman Jay Powell’s monetary policy has been way behind the curve.
Not only are the Fed’s actions too late, but a quarter-point move in the Fed funds rate – or a handful of such moves as is now projected – is too timid. Even if the Fed raises each month from now until June, the Fed funds rate will only be at a target rate of 1.00/1.25 over the summer. This is not an inflation-fighting rate move.
Rather, the Fed has indicated today that in 2 years it will bring the Fed funds rate to 2.80%, but that is two years until we are finally going to be fighting inflation.
In the meantime, the Fed has created a financial market that is dramatically overvalued with valuations in many sectors that are so irrational that equity investors are all but guaranteed to lose money. As rates rise, bond prices too are certain to fall. And, because the Fed’s move is so timid and inappropriate to address current inflationary circumstances, cash investors will continue to watch the deterioration of their real wealth as rates remain below anything even remotely necessary to ensure purchasing power parity.
Jerome Powell has allowed himself and the Fed to be frozen by his uncertainty. If this world has a future after Putin, he will certainly go down in history the worst possible Federal Reserve Chairman at the worst possible moment in time.
