A key question—perhaps THE key question—of the year is: has the Federal Reserve done enough to get inflation under control?
There are a couple of schools of thought out there on this question. The first suggests that the Fed simply needs to get the Federal Funds Rate—the short-term rate the Fed controls—above the inflation rate to stop inflation from rising.
Well, that we’ve done. As you can see on our featured chart above, the Federal Reserve has pushed the Federal Funds Rate (orange line) north of 5%, which is well above the CPI (gold line) at roughly 3%. So, from that perspective, maybe the Fed has done enough? And maybe this is an appropriate time to pause rate hikes?
However, another school of thought claims that the Federal Funds Rate needs to go even higher—to above nominal GDP growth (real GDP growth plus inflation). This is the green line on the chart. And as you can see, from that perspective, the Fed would still have more work to do.
Now, there is a precedent here to support that theory. As I’ve also highlighted on the chart, back in the late 1970s, the Fed pushed the Federal Funds Rate well above the CPI and nominal GDP. Ultimately, that helped slay inflation for good. But the question is: will such tight monetary conditions be needed today?
It’s hard to say. Some Fed officials have suggested at least one more rate hike is needed, which would be consistent with getting the Federal Funds Rate above nominal GDP growth. We don’t know for sure that will happen, but if it does, it would certainly create a more restrictive monetary environment for the economy and the stock market.
So, the takeaway for investors? We are still in an uncertain environment regarding monetary policy and inflation, and that could continue to create volatility in asset prices.
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