Why A Rebounding Economy is Terrible News for Fed’s Inflation Fight
US — It may come as a surprise for many, even for seasoned finance professionals, why supposedly “great news” in the form of rebounding economic factors can actually cause more harm than good. As we are all aware, the US Federal Reserve (Fed) has been undertaking an aggressive tightening monetary policy in the form of continuously hiking interest rates to curb the record-breaking inflation numbers in the first half of the year. Consequently, the economic environment followed the direction set by the central bank as the overall economy contracted.
Indeed, this has largely been the case for the year’s two consecutive quarters. Nevertheless, starting in the middle of June, the economic environment seemed to be cooling off as multiple “great news” occurred, speculating an economic rebound around the corner. Thus, let’s explore why some widely-accepted markers of a healthy economy could be hurting the Fed’s effort to finally curb its biggest enemy — inflation and, perhaps more importantly, delaying economic recovery.
Right Things at the Wrong Time
In the middle of June, the US Equity Market suddenly started a price rally. As a result, the S&P 500 saw a massive gain of more than 18% in two short months — a welcome shift of momentum celebrated by institutional and retail market participants alike. In addition, despite the contracting economy, the labor market has never been more ecstatic with the continued increase in employment as well as job openings. In fact, an estimated 300,000 jobs were added in August alone, which is on top of July’s unprecedented figure of 528,000 new jobs.
In addition, recent government data reveal that unemployment claims are declining and showing a downward trajectory, and surprisingly, consumer confidence seems to have shifted gears and has also started to increase. However, these seemingly positive economic events could have happened at the wrong time, perhaps at the worst time.
This is because these “positive economic events” fundamentally contradict the goal of the Fed’s tightening monetary policy, which is to bring down economic activity and halt economic expansion by reducing demand in the overall economy. Moreover, all of these seemingly positive events are inflationary in nature as they seek to expand the economy and further grow, which, if this happened during the typical expansionary environment, would be all great news; instead, however, it directly posed a direct threat to Fed’s current tightening policy to finally cut high inflation.
Watch our video on how a stock market rally may be bad news for bulls: https://www.youtube.com/watch?v=stHhk6LycI4&t=1s
A Bitter Pill to Swallow
In late June, Fed seemed to be starting to curb inflation finally. However, this invertedly caused the recent market rally we have mentioned as market participants expected that the Fed would finally waiver in its aggressive interest hike. Regardless, this hope was subdued when Fed Chair Jerome Powell himself stated that the central bank would continue its hike moving forward, causing the massive sell-off we are seeing today. Thus, the recent market sell-off is in the best interest of the central bank.
Fiona Cincotta, a Senior Financial Market Analyst at City Index, also warned about these positive economic events, saying, “Any positive surprises could trigger another sell-off.” In addition, she also commented on the strong labor market, saying, “If we do see a strong jobs market still, it means we’ll be in the rate-hiking cycle for longer.” This is because it will slow down the progress of the central bank as more jobs equal higher disposable income, creating higher consumer spending and demand.
Meanwhile, Brian Overby, a Senior Markets Strategist at Ally Invest, said, “Worse-than-expected data might mean the Fed could ease off the tightening gas pedal.” Thus, he perfectly summarized that if all economic factors have aligned and slowed down (drastically reducing inflation) as the Fed would prefer, then it would be counterintuitively more beneficial in the long run as Fed will not need to keep its tightening monetary policy for long, and we can go back to how it was before sooner rather than later.
