Rhetoric from relevant minds at the Federal Reserve escalated over the past month. Many important decision makers at the Fed have expressly stated that a half percentage point increase in interest rates is likely to occur when they meet next week. This is an acceleration in their tightening plans, which underscores two things: (1) inflation is a much bigger and persistent issue than they originally thought; and (2) the remedy is going to be stronger and more aggressive tightening of the money supply. Translation? The soft landing just got much harder. While this isn’t great news, it also does not mean we are headed toward a deep recession. Why? Give this article a read.
Supply/demand imbalance and recession risk.
The underlying issue is an imbalance in supply and demand. “Team transitory inflation” proposed that troubles arose from a supply side kink caused by COVID-19 and Ukraine/Russia tensions. But what happens when the supply chain stays kinked? How do you improve the imbalance? You address demand. The unprecedented worldwide monetary and fiscal stimulus that got the economy through COVID-19 relatively unscathed has led to a massive increase in the money supply and aggregate demand (too few goods + too many dollars = rising prices). With no solution to boosting supply in sight, the Fed is forced to erode demand instead.
War in Ukraine and earnings.
The ongoing war in Ukraine and current earnings season are impacting the markets on a smaller scale. The Ukrainian crisis has devolved into a messy war with abundant hardship and no signs of abating. Earnings have been fairly solid and surprise free. While important to the overall financial markets, these two factors are not the pressing drivers of the most recent bout of volatility.