One thing has become painfully obvious, after Friday’s consumer price index reading came in at a scorching 8.6% year over year, the highest reading since 1981. The Federal Reserve has been woefully behind the proverbial curve, and it may have to step on the interest rate increases pedal pronto. Former Reagan advisor and economist Art Laffer said last week that Fed Chair Jay Powell should go “full Paul Volker” and jack interest rates up huge.
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While the federal funds rate likely will not go to the incredible 20% level that American consumers faced in June of 1981, there are rumblings across Wall Street that the Fed could get more aggressive at this week’s meeting and the expected 50-basis-point hike could turn into a 75-basis-point increase. While a long-shot a month ago, it seems very plausible now, with inflation totally out of control.
Jefferies Chief Economist Aneta Markowska is one on Wall Street who thinks the 75-basis-point increase is indeed a possibility, and the Jefferies team noted this in a recent commentary:
Goods inflation has largely continued to roll, and service inflation has continued to rip. And sure, it’s summertime and folks have spent a few years being both cooped up and making money on speculative trading – travel is going to be better than the macro would otherwise support. But there are two very troubling aspects: 1) the cost of shelter continues to rise and that is sticky inflation and 2) the strong demand environment, mixed with supply constraints and shocks, has caused energy commodities to also put upward price pressure on the US consumer. With newfound confidence that inflation isn’t just going to go away soon, we remain of the view that several hundred more basis points of Fed Funds are probably on the horizon.
Typically in a rising interest rate environment, financials benefit from higher rates through increased profit margins. Industrials, consumer names and retailers also can outperform when the economy improves and interest rates rise. While the economy may not improve in the near term, it is likely with the country reopening after two years of COVID-19-induced stagnation that things could at least trend slightly better.
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