Fed Continues to Fight the Fire of Inflation

Investment Insights: Market Update
  • The Federal Reserve continues its efforts to fight inflation with another 0.75 percent increase to the overnight lending rate, and has confirmed the intention that these efforts will continue into the future.
  • Coupled with efforts to reduce the balance sheet, these efforts are expected to reduce the supply of easy money and should translate to reduced inflation pressure in the quarters ahead.
  • The balancing act will be to fight the flames of inflation, without undermining the economic positives that support a healthy economy in the meantime.

The Federal Reserve’s Federal Open Market Committee (FOMC) continued its firefighting efforts with another substantial increase in the benchmark Fed funds rate. This week’s increase of another 0.75 percent brings the interbank overnight lending rate to a target range of 3.00 to 3.25 percent in an effort to deprive inflation of the oxygen it needs to continue burning; cheap money. Furthermore, the Fed is most likely not done with its actions, as the newly published forecast of future rates (known as the “dot plot”) shows FOMC members believe Fed funds should be near 4.40 percent by year-end, implying two more hikes of 0.75 percent in November and 0.50 percent in December. Further out, markets and the Fed are both forecasting the highest Fed funds rate in this tightening cycle, known as the terminal rate, at approximately 4.6 percent in Q2 of 2023. While the new current rate is considered a historically “neutral” rate, it feels lofty to markets given the extended period of accommodative rates over the last several years. These next forecasted moves will push markets into a “restrictive” monetary environment, levels we haven’t experienced in fourteen years.

The Federal Reserve is also fighting to subdue the flames of inflation on its balance sheet. In the early pandemic era of March 2020, the FOMC began buying hundreds of billions worth of Treasury and government-backed mortgage securities on the open market in an effort to keep rates low and “push” money out into the marketplace. These actions doubled the Fed’s balance sheet from $4.3 trillion to $8.9 trillion. The Fed is now at full pace of allowing $95 billion in securities to simply mature and roll off the balance sheet. This has the effect of removing $95 billion in cash from the economy every month, further reducing the oxygen feeding inflation.

Given the newly revised dot plot and the remaining assets still left on their balance sheet, it is easy to see how the Fed has a lot of water left to throw on the inferno. With inflation burning the hottest we have seen in 40 years, much of those resources may be needed. Favorable market factors such as strong employment opportunities and resilient corporate earnings remain impressive but are caught in between stubborn levels of inflation and the current efforts necessary to combat it. While we expect the market to ultimately appreciate these efforts, the challenge of putting out the fire without overly damaging the building is a balancing act.

Market Dashboard

Financial market data for various time periods covering global asset classes.  Data as of September 21, 2022.

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Cyrus Charna
Investment Strategy Officer
Ben Baier
Lead Investment Officer
Wade Balliet
Chief Investment Adviser