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What will the Federal Reserve do next?

What will the Federal Reserve do next?

What will the Federal Reserve do next?

This is the question the major newspapers ask their readers in the Saturday morning papers.

On the second page of the Wall Street Journal we read: “Jobs report likely keeps Fed on track for March rate hike.”

On the front page of the Financial Times, we read: “US unemployment rate drops to 3.9%, giving Fed ammunition to raise rates.”

And, on the front page of the New York Times business section, we read: “Unemployment is falling rapidly, adding pressure for interest rate hikes.

Why is this important?

Well, Gunjan Banerji and Anna Hirtenstein write in the Wall Street Journal:

“The S&P 500 kicked off the new year with a new high on Monday, but came under further pressure after the Federal Reserve minutes confirmed its intention to withdraw stimulus and suggested it may do so more. sooner and faster than expected, due to high inflation. “

“Friday’s December jobs report was the latest of several puzzling signs of the economic recovery that investors are evaluating.”

As mentioned earlier, the unemployment rate has fallen to 3.9%, a number that many analysts accept as close to what is considered “full employment.”

And, if the economy is very close to the level of full employment, with lots and lots of liquidity surrounding the financial system, then the economy must be sensitive to higher inflation rates.

If sustained and higher inflation rates are on the horizon, the Federal Reserve needs to get back on track and tighten monetary policy.

This means less cash and higher interest rates.

New stock market highs

The new year has started off well with the stock market hitting new all-time highs.

The Dow Jones Industrial Average closed Monday and Tuesday with new all-time highs.

The Standard & Poor’s 500 stock index hit a new all-time high on Monday.

My assessment at the time was that investors interpreted the Federal Reserve’s stance as one where interest rates would be allowed to rise in 2022, but the Fed didn’t seem very determined to sell part of its portfolio of securities, hence bank liquidity. would not be threatened.

However, as the week went on, more and more analysts began to believe that the Federal Reserve might indeed be working to reduce bank liquidity, thereby acting in a more restrictive way than previously thought.

As a result, all of the major stock indexes fell for the remainder of the week.

Index performance until January 7, 2022

Inflation data

But, on top of that, more information about the rising inflation rate has emerged. And, the inflation information showed that the inflation problem was not just an American problem.

Inflation in Europe hits a new high.

“The European Union’s statistics agency said on Friday that consumer prices in December were 5% higher than a year earlier, a recovery from the previous record of 4.9% in November.”

This increase raises questions about the monetary stance of the European Central Bank. ECB President Christine Lagarde argued that the European Central Bank should pursue its quantitative easing policy a little further. Ms Lagarde was not ready to raise European interest rates at that time.

This, of course, was good news for the Federal Reserve System, as it meant any tightening it could make would not be matched by another major central bank.

Now, with European inflation rates rising, Ms Lagarde and the ECB may find it a bit more difficult to maintain such an accommodative stance.

And, if the ECB starts raising its policy rate, that will only put more pressure on the Federal Reserve to raise its policy interest rate.

Here is an overview of the inflationary situation in the United States and in Europe.

Consumer price inflation - United States and euro area

But we are not yet finished.

The employment situation in the United States

Also, on Friday, investors got new information on the labor market.

First, as mentioned above, the unemployment rate fell to 3.9 percent, indicating that the US labor market was not doing too badly. And, in 2021, the United States added a record number of jobs to the labor market.

Second, the latest jobs report found that the average hourly wage in the United States rose 4.7% in December from the previous year.

Wage growth before the start of the pandemic was around 3.0%.

This discrepancy, of course, raises concerns about how wage pressures might impact the future of inflation.

Investors are worried about this connection and it was reflected in the stock market over the weekend as well.

Stock market breakdown

Mr. Banerji and Ms. Hirtenstein spend some time analyzing stock movements.

One thing they point out is the bifurcation that takes place in the stock market:

“Below the surface, the selloff has been even more extreme. Almost 40% of Nasdaq Composite shares have lost half of their value, and nearly two-thirds are in bear markets or are 20% below their market value. summits. “

“This is a dynamic that has not emerged since 1999 and underscores how volatile individual stocks have been as investors position themselves for the next phase of the economic recovery.”

Obviously, a lot is happening in the stock market these days, representing the states of imbalance and dislocation that exist within the economy.

There is a lot going on and in this time of drastic uncertainty, volatility is to be expected.

Back to the Federal Reserve

This brings me back to the Federal Reserve.

For me, the Federal Reserve created this situation. And that’s not a good situation.

To discuss what’s going on in the stock market, I’ve spent over three-quarters of this article talking about what the Fed is doing or what it could do.

This is not the way it should be.

If the Fed is doing its job and doing it well, we shouldn’t be discussing it at all. We should focus on companies, sectors or more micro-issues.

But here we are and the Fed is dominating the scene. So, we need to keep focusing on the Fed and what the Fed plans to do. 2022 could be a very interesting year.

If investors think the Fed is tightening monetary policy, don’t be surprised by the stock market decline.