How Far Will The Fed Go to Fight Inflation?

By: Adam Sharp
Editor, The HIVE Newsletter
Nasdaq: HIVE | TSX.V: HIVE

The Federal Reserve is in a historically tough spot.

If it continues raising rates, asset and equity markets will likely fall further. That may help cool inflation, but it will also cause all sorts of other problems globally (which we’ll get into in a bit).

First, let’s look at what the Fed is expected to do near-term.

The market currently expects (via CME Fedwatch) the Fed to hike interest rates by 0.75% to 1% on July 27, 2022.

Investors are expecting another 0.75% raise at the September meeting. That would put the Fed Funds rate at 3.25% to 3.5%.

After the September Fed meeting, markets so far are pricing in another small (.25%) hike or a pause. The farther out we go, the murkier the outlook becomes. 

For now, the Fed seems determined to slam the brakes on the economy, and asset prices. The shocking 9.1% CPI release will likely lead to at least a few more hikes.  

The question is, how long can the US, and the world, handle it?

Can We Handle Higher Rates?

Today the Fed funds rate is still only about 1.75%. It will likely be over 3% after the September FOMC meeting. 

That’ll still be far below the historical average of 5%+.

Yet even such a small move has already had enormous effects. From June 8 to July 8, 2022, oil prices are down 22%, and copper has dropped 25%. Bitcoin is down about 30%, from $30,000 to ~$20,000 in the same span.

Wheat, fertilizers, and many other commodities are also well off their highs. 

So the Fed strategy is, at least in some ways, working. But the typical rule with inflation is that the central bank interest rate needs to be at least as high as inflation to control it. Could the US economy handle 9%+ interest rates? It doesn’t seem likely to me.

It’s likely that higher rates become problematic far before we get near the rate of inflation. 

Downsides of Higher Rates

If rates keep rising, and we enter into a recession, it seems probable we’ll see a larger fall in stock markets. That alone would cause significant problems. 

A more significant crash could cripple American consumer spending, while lowering government tax revenue. It would also hurt pensions and retirement plans, many of which are underfunded.

Overleveraged corporate borrowers may struggle to refinance their debt at affordable levels. Combined with supply chain problems, and inflationary woes, a wave of companies defaulting becomes possible. 

In a rising rate environment, housing prices will likely fall. That’d be good for housing affordability, but bad for most people’s wealth, which hurts spending.

It’s an incredibly complex situation. There seem to be few good choices for most central banks.

Hodl the Line?

As the consequences of higher rates continue to set in, will the Fed hold strong and keep monetary policy tight? Is this finally when we “take our medicine”? 

Those are the questions every investor around the world is asking today. The answer will likely determine the price action in Western economies for some time to come.

I am still of the opinion that we will see an eventual Fed pivot. Meaning that our central bank will be forced to buy massive amounts of Treasuries to finance deficits and stimulate the economy.

But it seems likely there will be more pain first. A Fed pivot could be a year away, or it could happen in months. For now the Fed wants to cool off housing and other bubbles, which it possibly should have done a lot sooner.

It seems the Federal Reserve will attempt to maintain its delicate tightening act, while leaving the door open for an eventual reversal. 

Eventually I do believe the Fed will return to what has become their core mission: bailing out the economy with trillions of dollars. Higher rates are going to hit world economies hard, and if history is any guide, central banks will react to the downturn using accomodative monetary policy. 

On July 14, 2022  the Bank of America analysts cut their year-end S&P 500 target by 25% to 3,600. Notably, the bank also now expects interest rate cuts in the second half of 2023.

If and when central banks do fire up the printers, I expect Bitcoin (and other scarce monetary assets) to be prime beneficiaries. 



Adam Sharp
Editor, The HIVE Newsletter