(MENAFN- Khaleej Times) The data points on inflation in the US and Germany are now impossible to ignore. Average hourly earnings rose at 2.9 per cent and triggered a risk asset meltdown on Wall Street. The US consumer price inflation then rose to 2.1 per cent (1.8 per cent ex-food and energy) while the IG Metall union negotiated a 4 per cent wage hike with German automakers. The monthly CPI report just confirms that the Federal Reserve will have to continue its interest rate hikes under Jerome Powell, with a certain hike at the June FOMC.
Fed monetary tightening will accelerate as the impact of the US tax cut boosts economic growth and consumer spending. The money markets price in two rate hikes in 2018. This is unreal. The inflation and growth metrics in the US economy argue for four or even five Fed rate hikes. Note that the price of gasoline, rent and medical care, all essentials of life, all spiked higher in January. The bond vigilantes of the 1990s, who forced President Clinton to slash government spending in the quest for a balanced budget, could well test the Powell Fed in the Chicago bond futures pits as early as this summer.
My real fear is that the bond vigilantes will overreact, force the Powell Fed into an accelerated monetary tightening that will cause asset valuations to sharply compress and trigger a spike in borrowing costs that will gut consumer spending, retail/auto sales and home prices. In fact, an inverted Treasury bond yield curve, as in 2000 and 2007, could well be a prelude to a recession or at least stagflation in 2019.
President Trump's fiscal stimulus (tax cut) in the ninth year of an economic expansion will only amplify the inflation fears in the bond market and raise the odds that the Powell Fed is "behind the curve" in its anti-inflation mandate. The fall in the US Dollar Index from 102 last March to 80 now reflects precisely this fact, coupled with higher Uncle Sam budget deficits, a widening current account deficit and growth acceleration in Europe and Asian emerging markets.
Last week's weakness in US retail sales is temporary, due to the severe winter and an awful fun season. This does not negate the fact the inflation pressures are now accelerating in the US economy. Note that the US dollar's sharp decline in 2017 will raise the prices of foreign imports and the almost 50 per cent rise in Brent crude since last summer will take its toll on energy costs. If the US economy begins to generate 250,000 monthly new jobs, the Fed will have reached the limits of its dual mandate and may well have to signal the seriousness of its intent with a 50-basis point rate hike.
As I watch retail investors mindlessly speculate in offplan property launches (enriching brokers with a 6 per cent fee), I wonder if these poor people realise that three-month Libor/Eibor could well double in the next two years and trigger a 30 per cent fall in property prices. It is insane to bet on future property prices in highly speculative off-plan contracts when the Fed is tightening and the property market is struggles to cope with existing, let alone new supply.
The bottom line is that the capital markets are simply not braced for more Fed rate hikes than Dr Janet Yellen's projected dotplot (three rate hikes in 2018). This is why every investor in the world should watch US payroll data, wage inflation and bond prices like a hawk. Money is on death watch now.
It is surreal that the midpoint Fed Funds rate is a mere 1.38 per cent as US inflation rises above 2 per cent, wage growth above 3 per cent and synchronised global GDP growth above 4 per cent (IMF data). The Powell Fed is well behind the curve on inflation in this mature stage of the global business cycle. The Fed Funds rate should be at least 200 basis points above inflation when the US economy is at full employment, wage push inflation is accelerating and crude oil prices have doubled from their lows.
The Federal Reserve is forced to respond to rising inflation risk at the same time as it shrinks its $4.5 trillion balance sheet. It is now obvious that Janet Yellen made a monumental mistake in not hiking rates thrice in both 2015 and 2016. The world will pay a high price for her "data dependent" Fed.
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