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The Fed's Hammer - Breaks Economy Then May be Inflation

Last night Federal Reserve hiked interest rates by another 0.75% and this is the third consecutive hike with this amount of increase. With this, US 2-year bond yield rose above 4% which was last witnessed pre-global financial crisis, and the Dollar index rose above 110 which was last witnessed post-dot com bubble burst. These levels are crucial to the prospects of an economic crisis that is in a making.

The important thing that was mentioned in the projection of the Federal Reserve policy was the unemployment rate increasing from the current 3.7% to 4.4%. But if historical trends are looked at, it can be seen that the rate of increase in unemployment is much faster during rate hike cycles as compared to the rate of decrease during rate cut cycles.

The policy also mentioned that any inflation target will be only achieved by 2025 but the during the speech, Fed Chair Powell mentioned that a recession is likely but the details of it are unknown. This resembles the speech when inflation was likely and the details were unknown.

Though there are certain indicators that the rate of hikes will reduce as action speaks louder than words, post the policy equity indices fell by 1.7% with VIX closing slightly above. Though there will be many economists and brokerages reconsidering the estimates, the trajectory of the central banks trying to hammer down inflation is not reducing as we enter the winter season.

The hammering is likely to break the economy first rather than inflation. To this claim, the global CDS ( Credit Default Swap) market saw trades worth $30bn on 20th Sept 22. This is the largest value since Dec 2019, that was just before markets crashed in the next quarter.


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