the Fed is about to strike a blow to curb inflation

Another sharp rise in interest rates can be seen in the United States. Fifteen days after the European Central Bank (ECB) raised its rates by 75 basis points in early September, the American Federal Reserve (Fed) is preparing to strike a blow to try to curb the inflation that exceeded 8% to announce another rate increase, the fifth of the year. With US rates currently in the 2.25-2.50% range, most experts expect a 75 basis point increase, although some are talking about a 100 basis point scenario.

“The Fed is likely to increase by 75 basis points today and predicts an additional 100 basis points (1 percentage point, editor’s note) by the end of the year”, expected Ian Shepherdson, economist at Pantheon Macroeconomics.

On the other hand, almost one in five market participants expected a stronger increase on Wednesday, by one percentage point, according to CME Group’s futures product valuation.

Since Fed Chairman Jerome Powell’s speech in Jackson Hole (Wyoming) at the end of August, investors are actually expecting a faster and longer monetary tightening than first expected. Operators now favor the hypothesis of a Fed rate of at least 4.50% at the end of the year, against 3.75% a month ago, an altitude unknown to the institution since almost 15 years.

Financial market concerns

Currently, while waiting for the Fed’s decision, the financial markets are struggling. This Wednesday, after the European stock markets and Wall Street ended in the red on Tuesday, the Chinese stock markets opened the day on Wednesday. In the first exchanges in Hong Kong, the Hang Seng index gave 0.76% to 18,638.85 points. For its part, the composite index of the Shanghai Stock Exchange lost 0.47% to 3,107.75 points, while the Shenzhen square decreased 0.70% to 1,997.60 points.

By raising rates, the Fed wants to curb inflation which, although it slowed down in August thanks to lower fuel prices, remained at 8.3% per year, a level higher than expected. The Fed wants to avoid a repeat of the 1980s scenario when rates jumped 15%

And this is despite the risk of recession caused by the consequences of a rate hike, not only in the United States but also in the global economy. However, the good performance of the American labor market, with the unemployment rate at the lowest level in 50 years (3.7%) gives the Fed room to achieve a “soft landing” .

US bond yields at record highs

However, the aggressiveness of the US central bank’s monetary policy is already being felt. On Monday, US bond yields rose to their highest level in eleven years. US 10-year Treasury bonds reached 3.51%, a first since April 2011. The 2-year rate, considered more sensitive to market expectations about the Fed’s monetary policy, rose to 3.96%. , the first in almost 15 years. As for the one-year yield, it exceeded 4% for the first time in 21 years.

“Yields are at their highest in years, but Fed rates are also at multi-year highs, as inflation itself is at 40-year highs,” said John Canavan, of Oxford Economics.

Corporate financial conditions are tightening

This hot season in the bond market is already weighing on corporate financing conditions. The average rate for a 10-year loan for the best American companies jumped by almost a point since the beginning of August. For companies with the lowest score, the average cost of credit is close to 9%, compared to around 4% just a year ago. The real estate market is also on the front line, with the average rate for a 30-year mortgage rising above 6% last week for the first time since 2008.

“We think we’re almost at the top,” said Lawrence Gillum of LPL Financial. “It is possible that we will go up to 3.75% for the 10-year rate, but because of the search for yield and the fact that we will probably experience a recession within twelve months, we will see a decrease in the rate. For him , rising interest rates make bonds more attractive and, in the context of equity markets continuing to retreat, many investors will be able to return to this investment in the coming months. bond prices move in the opposite direction to their rate, the changed appetite for these products will automatically lower their yield.

Debate on the need to raise rates

However, not everyone shares the monetary policy implemented by most central banks around the world to fight inflation.

“It reminds me of what happened with bloodletting,” said Nobel laureate in economics Joseph Stiglitz in an interview with AFP, referring to the ancient practice of making the patient bleed to heal him. “When a patient is bled, he usually doesn’t get better, except for a miracle. So they made his blood flow more, and his health improved. I fear that the central bankers are doing the same now,” the economist criticized.

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“Does the economy really need this to maintain the brakes? asked Eric Dor, director of economic studies at the IESEG business school. According to him, “inflation itself creates a decrease in activity, households lose purchasing power , the increase in wages is lower than inflation, and represents a brake on consumption”, especially for Europe where the rate increase risks further weakening the economy.

“Does it cause a little loss of growth?” It’s possible,” European Central Bank boss Christine Lagarde acknowledged last week at a conference in Paris. But for him, “it’s a risk we have to take by measuring it well”.

According to Joseph Stiglitz, the inflationary surge is due less to excess demand than to energy and food price increases and continued blockages in supply chains. Events in which central bankers have a smaller field of action. They “used a medicine that resulted from a bad diagnosis”, hammered the economist, warning that we will see in the United States the prices of rents continue to rise under the effect of rising rates, and therefore inflation continues.

“The risk is that without any real impact on inflation, this policy worsens the cost in terms of activity and employment”, added Eric Dor about Europe.

The ECB will continue to fight inflation

Critics the ECB doesn’t want to hear. This Tuesday, Christine Lagarde recalled that the Central Bank must do everything to prevent the effects of rising prices from “embedding” permanently,

“We will not allow this phase of high inflation to influence economic behavior and create a lasting problem of inflation”, added the president of the monetary institution, acknowledging that the increase in the prices of euro zone “proved to be much longer and more persistent than originally expected.”. Christine Lagarde believes that the double conversion of the pandemic and the invasion of Russia in Ukraine “caused changes in our environment in economy”, with continuous consequences on the structure of supply and demand. “The cut of gas supplies due to the invasion of Russia has become a major structural change with consequences for many years”, he described in particular, that fossil fuel prices “are likely to be higher for some time”.

“If energy prices are permanently higher during the transition period, this could have an impact on European industrial production, affecting supply and prices,” said the head of the ECB.