Is the Fed Twice Late?

With an interest rate hike of three quarters of a percentage point, the Federal Reserve continues to push the inflation brake hard. There are increasing signs that the inflation peak is already behind us. For now, the dollar is the big winner, even if the US central bank's policy change comes too late.

The US central bank raised interest rates by three-quarters of a percentage point last night. It had been clear for some time that an interest rate move of this magnitude was imminent. The financial markets therefore paid more attention to the tone that the Federal Reserve was adopting than to the rate hike itself. The main message was that more interest rate hikes are in the pipeline. The central bank is not afraid to hurt the economy, if necessary to control inflation. The Federal Reserve predicted that rising interest rates will help slow economic growth to 0,2%, while unemployment will rise from 3,7 to 4,5%.

Vigor!
When you consider that the consumer price index (CPI) has been above 8% for months, the Fed's decisiveness is understandable. That picture changes when you look at how the inflation figure is constructed and at the track record. To start with the first: this year, the increase in the CPI from 1,4% to 8,3% is mainly caused by higher energy and housing costs. However, a clear turnaround is taking place in both markets. The price of Brent oil fell from over $120 a barrel in early March to below $90 now. Even if oil prices remain at current levels, energy prices will push inflation down sharply in the course of 2023. The same applies to housing costs. The prices of American houses have already started a significant decline in recent months.

Or would you rather wait?
To be fair, the CPI is not the most reliable pointer on the Fed's inflation compass. The central bank prefers to look at personal consumption expenditure (PCE). This inflation figure provides a more complete picture of the actual spending trend of American households. But this inflation rate at 6,3% is already a lot closer to the 2% the Fed is targeting than the CPI. In addition, the bank has no reputation to uphold when it comes to forecasting and controlling inflation. For example, the first rate hike did not come until mid-March. At that time, inflation was already well above the Fed target, while it was clear that the increase would continue strongly.

Don't bet against the dollar (yet)
There is a real danger that the Fed will again make the switch too late. If the central bank continues to raise interest rates for too long – just as it waited too long with the first rate hike at the beginning of this year – this will put an unnecessarily large brake on economic growth. Incidentally, both a further rise in US interest rates and concerns about a possible approaching recession play into the dollar's hands. The currency is also a safe haven in economically uncertain times. It is therefore unwise to bet against the dollar in the coming months. It would be wiser to wait until US inflation declines further in the coming months.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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