With core PCE inflation in January rising to 4.7%, the unemployment rate at the lowest level since the 1960s, and 2-year breakeven inflation expectations becoming unanchored, the Fed is about to turn significantly more hawkish.
Based on the latest data for inflation and unemployment, the Taylor Rule is now suggesting that the Fed funds rate today should be almost 10%, and it is becoming clear for the Fed that a sharper slowdown in the economy is needed to get inflation under control, in particular with the housing market showing signs of rebounding.
A generation of investors has since 2008 been taught that they should buy on dips, but today is different because of high inflation, and credit markets and equity markets are underestimating the Fed’s commitment to getting inflation down to 2%.
The Fed is now so far away from its dual mandate that the FOMC may not only consider using more hawkish forward guidance and raising the Fed funds rate but they could also accelerate the rundown of their balance sheet. The no landing scenario continues and the consequence is that we will continue to have high volatility in markets.
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