July 14, 2022
👀 Tomorrow's retail sales report will be an important one to watch, as a hot reading would make Fed officials more inclined to step up the pace of rate increases.
- See more below on the risks if they go for a full percentage point rate hike after a June inflation surge, and a warning from the IMF as finance ministers gather in Bali with, one suspects, minimal time to hit the beach. 🏝
Today's newsletter, edited by Kate Marino, is 695 words, a 2½-minute read.
1 big thing: The problem with monetary shock and awe
Before anyone had time to fully parse yesterday's inflation numbers, the rumbling had already begun on trading desks and research shops: Maybe the Fed will, in two weeks' time, raise interest rates by a full percentage point — the most at a single meeting in its modern history.
- This possibility shows the jam the Fed has gotten itself into.
Why it matters: Fed officials seek to convey a whatever-it-takes sense of urgency. That has put them in a situation in which high inflation readings demand an ever-escalating series of policy moves that, taken to their logical conclusion, end with a cratering economy.
State of play: Just last month, a high May inflation reading drove Fed leaders to make a last-minute shift to raise interest rates by 0.75 percentage points, not the half-point they had long signaled.
- Here we go again. Wednesday's release showed a 9.1% rise in the Consumer Price Index over the last year — and perhaps more significantly, the uptick of monthly core inflation to 0.7% in June.
- It was a "major league disappointment," as Fed governor Christopher Waller said in a speech this morning.
- It set off alarm bells throughout the financial world that recent history would repeat and, by day's end, futures markets would be fully priced in a one-percentage-point rate hike in late July.
Between the lines: The handful of officials who have spoken publicly since the release have appeared open-minded about whether escalating inflation requires an escalating policy response.
- In Waller's speech today, he said he currently favors sticking to a 0.75 percentage point rate hike, but that if retail sales and housing data due out in the coming days are "materially stronger than expected, it would make me lean towards a larger hike at the July meeting."
The risk: To the degree the Fed responds to high inflation readings not just with rate increases, but with increasingly larger rate increases, it's all but inevitable the Fed will over-tighten monetary policy and cause more economic pain than is necessary.
- Followed to its logical conclusion, it would mean eventually ending up with an excessively restrictive policy, as the Fed makes ever-bigger policy moves in response to what happened in the past rather than what will happen in the future.
What they're saying: "Simply chasing headline inflation higher with ever-larger units of hiking and a backward-looking outcome-based rule for stopping raising rates is likely to end badly," wrote Krishna Guha, Evercore ISI vice chairman, in a research note.
- As Kansas City Fed president Esther George, generally a monetary hawk who nonetheless dissented at the June meeting, said in a speech this week, "Moving interest rates too fast raises the prospect of oversteering."
The bottom line: The Fed has spent the last year behind the curve in fighting inflation. But there are perils in trying to fix that all at once.
2. IMF's blast-from-the-past fiscal warning
As G20 finance ministers gather in Bali this week, the International Monetary Fund published a blog post warning about the global economy's "sea of troubles."
- "It is going to be a tough 2022 — and possibly an even tougher 2023, with increased risk of recession," IMF managing director Kristalina Georgieva wrote.
Details: The IMF is calling on countries to do "everything in their power" to slow price growth as the global inflation crisis mounts — while urging governments to carefully assess the use of fiscal policy to support the economy.
What they're saying: "New measures must be budget-neutral — funded through new revenues or expenditure reductions elsewhere, without incurring fresh debt and to avoid working against monetary policy," Georgieva wrote.
- She also wrote that reducing debt is an "urgent necessity" in developing economies with debt denominated in foreign dollars that are most vulnerable to soaring borrowing costs.
Between the lines: This is somewhat of a throwback to calls for fiscal austerity that the IMF had moved away from, most recently during the onset of the pandemic.
What's next: The IMF will likely slash its global growth forecast again later this month, according to the blog post.
- In April, it projected the global economy would slow to 3.6% growth in 2022, down from 4.4% (before Russia invaded Ukraine).