Article | "Financial National Weekly" Tan Shusen "The market is dying for the Federal Reserve." A seemingly ridiculing sentence by market participants actually expresses the current helplessness of many American investors. On June 16, local time, the three major U.S. stock indexe

Article | "Financial National Weekly" Tan Shusen

"The market is dying for the Federal Reserve ." A seemingly ridiculing sentence by market participants actually reveals the current helplessness of many American investors.

On June 16, local time, the three major U.S. stock indexes continued to plummet. Among them, the Nasdaq index , dominated by technology stocks , fell by more than 4%, and the S&P 500 index fell by 3.25%, both of which have entered the Technical bear market ; the Dow Jones Index composed of blue chip stocks fell below the 30,000-point mark, approaching a bear market.

html Traders work at the New York Stock Exchange in the United States on June 16. Xinhua News Agency Posted by Guo Ke Photo

html On June 15, the Federal Reserve’s interest rate meeting decided to raise the federal funds rate by 75 basis points to the target range of 1.50%-1.75%, and continue to reduce the balance sheet and recover liquidity as planned.

75 basis points of "violent interest rate hike" is in line with market expectations in the past week, but significantly exceeded market expectations a week ago. This is because data released by the U.S. Department of Labor on June 10 showed that the U.S. consumer price index exploded again in May. The 8.6% year-on-year increase not only exceeded market expectations, but also set a new inflation record since December 1981.

Previously, U.S. inflation rose by 8.3% year-on-year in April, down from the 8.5% increase in March. Many market participants believed that inflation had peaked. However, the inflation data that rose again in May dispelled the "peak inflation theory" and allowed the world's largest economy to enter an epic interest rate hike cycle.

As the world's largest central bank the Federal Reserve raises interest rates , the world's major economies are becoming nervous. The high inflation rate and drastic tightening measures will inevitably bring about drastic adjustments to the capital market.

Powell's misjudgment

"If we treat it as a hindsight, it would be better to raise interest rates earlier." This is the recent statement of Federal Reserve Chairman Powell.

html On June 15, in Washington, the capital of the United States, Federal Reserve Chairman Powell spoke at a press conference. Photo by Xinhua News Agency reporter Liu Jie

The reason why I say this is because for most of 2021, Powell has been an advocate of the "temporary inflation theory." At the press conference after the Fed's interest rate meeting in March this year, Powell said that inflation is expected to be relatively high in the coming months, but this will be temporary. The economic indicator forecast released by the Federal Reserve at the time showed that the forecast value for inflation in 2021 was 2.4%, and it would fall back to 2.0% next year.

Until the Federal Reserve interest rate meeting in early November 2021, Powell still insisted on the "temporary inflation theory," but his optimistic expectations for inflation levels began to converge. In the meeting statement, the Fed changed its statement on high inflation from "temporary factors" to "expected to be temporary factors."

The real change occurred on November 30th. Powell acknowledged at a congressional hearing that while he expects inflation to weaken "significantly" in 2022, it is no longer appropriate to describe price pressures as "temporary."

While Powell insisted on the "temporary inflation theory," the "inflation threat theory" represented by Lawrence Summers emerged in the U.S. economic circle, and the two argued endlessly.

Lawrence Summers served as Treasury Secretary in the Clinton administration and served as Director of the National Economic Council during the Obama administration. Since the first half of 2021, he has repeatedly warned that inflation is "at risk of getting out of control", seeming to be playing against Powell.

He said that the large-scale monetary and fiscal stimulus in the United States, coupled with the reopening of the economy, will bring considerable upward pressure on prices. He criticized the Fed's loose monetary policy for bringing "dangerous complacency" to the market, and warned that the Fed may be forced to conduct "reflexive" interest rate hikes in the future.

While many people in the White House and the Federal Reserve are saying that inflation is moderate and controllable, Summers is clearly one of the few "personality" people among his Democratic colleagues.

Soon, former Federal Reserve Chairman Alan Greenspan joined the ranks of critics. He believes that the U.S. inflation rate faces continued risks of rising significantly. "Although some factors pushing up prices may be temporary, the accumulation of government debt and other deep-seated pressures may keep the inflation rate high for a long time."

Inflation is as fierce as a tiger.Since last year, the price level in the United States has accelerated, which has affected the lives of many people, especially low-income groups.

In early December 2021, a Gallup poll showed that at the beginning of the Christmas shopping season, 45% of Americans said they had experienced financial difficulties due to rising prices. Consumers with different income levels have different feelings, and price increases have a particularly obvious impact on low-income families. 71% of American households with an annual income of less than $40,000 said that rising prices have caused them to encounter financial difficulties; among middle-income households, 47% said they encountered financial difficulties; among high-income households, this proportion was 29%.

Also affected by inflation is the Biden administration. High inflation has severely weakened President Biden's approval rating. The Republican Party took advantage of the situation to lash out at the Democratic Party. Biden and the Democrats face a headwind heading into this fall's midterm elections.

Will raising interest rates tame inflation?

Originally, maintaining price stability is one of the core goals and tasks of the Federal Reserve. Was Powell's misjudgment unclear about the economic and price situation, or was he influenced by American politicians?

On May 31, local time, US President Biden met with Treasury Secretary Yellen, Federal Reserve Chairman Powell and others at the White House, focusing on the issue of inflation. Biden said he respected the "independence of the Federal Reserve." Yellen even admitted more than once that she had misjudged the inflation situation before. Obviously, "inflation is the primary problem in the United States" has become the consensus of the U.S. government and the Federal Reserve.

html On June 14, in Washington, the United States, a woman walked out of a food supermarket carrying shopping bags. Xinhua News Agency Photo by Shen Ting

It is not too late to remedy the situation. But, to what extent can the Fed raise interest rates to tame inflation?

At present, the inflation situation is severe, and both the Federal Reserve and the market seem to be "preparing for the worst." Most analysts believe that it is possible for the Federal Reserve to raise interest rates to around 3.5% within the year. However, the Fed is not unscrupulous. While "suddenly braking", it needs to consider whether the economy will fall into a recession, or will economic recession inevitably be the price of taming inflation?

Since the current inflation level is close to that of the early 1980s, people naturally think of Volcker's name. Who is Volcker? In 1979, when U.S. inflation reached 13%, Paul Volcker became chairman of the Federal Reserve. Under his leadership, the Fed slowed the growth of the money supply and raised interest rates sharply. These policies led to the economic recession in the United States in 1982-1983, but inflation was effectively controlled.

This not only won Volcker his reputation, but also laid the foundation for advanced economies to enter the next years of low-inflation economic growth. However, at the most tense moment of the fight against inflation, Volcker claimed to be "tied to the mast" and exerted great courage.

But will just having the courage to raise interest rates solve the problem? I'm afraid not necessarily. At present, the scale of the U.S. federal government's debt has exceeded the 30 trillion U.S. dollar mark, which is approximately 1.3 times the U.S. GDP. Every time the interest rate center in the United States rises by 1 percentage point, the federal government will increase interest payments by hundreds of billions of dollars. If the federal funds rate rises above the 10% level seen in the early 1980s, it will also be a nightmare for the U.S. government.

In December last year, the U.S. Congress passed legislation to raise the federal government's debt ceiling by US$2.5 trillion to US$31.4 trillion, temporarily avoiding a government debt default. The U.S. Congressional Budget Office warned that an increasingly heavy debt burden and higher inflation could increase the risk of a fiscal crisis and undermine market confidence in the U.S. dollar.

The Federal Reserve Building photographed in Washington, USA on April 20. Photo by Xinhua News Agency reporter Liu Jie

It’s not just a monetary factor

“Inflation is a monetary phenomenon that causes long-term general rise in prices.” This is a typical explanation for inflation.

Inflation is a monetary phenomenon, often the result of excessive currency issuance. This is particularly evident in the current price rise in the United States. After the outbreak of the new coronavirus, the Federal Reserve's "helicopter money" model caused flooding of liquidity. While people enjoyed rising asset prices such as the stock market and property market, they also pushed up price levels.

However, this round of inflation in the United States is not only caused by monetary factors. Regarding the 8.6% comprehensive price increase in the United States in May, some American institutions conducted a quantitative analysis and believed that the main factors were the Russia-Ukraine conflict directly or indirectly pushing up commodity prices, the supply chain tension caused by the COVID-19 epidemic, and the increase in housing prices.

The NATO led by the United States continues to expand eastward, compressing Russia's geopolitical space, and constantly "adding fuel to the fire", eventually triggering the Russia-Ukraine conflict. After the crisis broke out, the United States and its allies repeatedly initiated sanctions against Russia, which impacted the global food and energy markets and pushed global commodity prices to rise rapidly.

In addition, the United States has held high the banner of protectionism in recent years, setting off a countercurrent to globalization, especially exerting extreme pressure on China, which has seriously disrupted the global industrial and supply chains.

Who can you blame? It can only be said that the United States "shoots itself in the foot" and "drinks its own bitter wine."

Academics believe that inflation often makes the rich richer and the poor poorer. This explanation is easier to understand if the situation between Russia and Ukraine is taken into account. By exporting weapons, the United States has made a fortune for arms dealers, but the consequences of inflation need to be borne by ordinary Americans.

html On May 11, a customer was shopping in a supermarket in New York, USA. Photographed by Xinhua News Agency reporter Wang Ying

Housing prices are a "double-edged sword"

Along with the rise in commodity prices, there are also housing prices. U.S. home prices hit a record high in March. Mortgage rates hovering near historic lows are fueling demand for home purchases.

The monthly housing trend report released by the U.S. brokerage website on March 31 showed that the median housing price in the United States was $405,000, and the record-breaking median price increased by 13.5% from March 2021.

The Case-Shiller Index, which mainly measures housing prices in large cities, shows that in March this year, the comprehensive housing price index for 20 major cities in the United States rose by 21.2% year-on-year, the largest year-on-year increase in 35 years.

After the house price rises, the rent rises. U.S. rent growth has reached double digits, according to data from brokerage websites.

Related research shows that housing costs, a component of consumer prices, are not only unlikely to fall quickly, but will continue to grow in the coming months. Currently, private sector rent growth is still at 16%, and residential inflation is likely to be close to 7% by the end of 2022, contributing close to 3 percentage points to core inflation.

According to data from the Mortgage Bankers Association, the scale of home purchase loans in the United States will reach US$1.61 trillion in 2021, and the stock of housing mortgage loans is approximately US$11 trillion. For every 1 percentage point increase in interest rates, American households will pay $100 billion more in interest on their mortgages, and demand for new home purchases will also be affected.

People will never forget that the subprime mortgage crisis in 2008 was related to mortgage loans. History may not repeat itself, but people who are accustomed to a low interest rate environment should still fasten their seat belts when faced with a sudden rise in interest rates.

Source: Xinhua News Agency