Federal Reserve Chairman Jerome Powell dropped a rate rise bomb into his monthly press conference last night by raising the Fed’s inflation expectations. In addition, Powell effectively moved up the time frame on rate rises by indicating rises could come as early as 2023 rather than 2024 as previously forecast.
The Fed had confirmed as recently as its March meeting that the 2024 timetable remained in place.
So what changed? In a word, inflation. Powell said, “Inflation has come in ahead of expectations in the last few months.” The Fed’s Chairman went on to say: “Is there a risk that inflation could be higher than we think? Yes.”
The Fed has moved up its headline inflation forecast for the year from 2.2 per cent to 3.4 per cent. Concurrently the Fed also raised the expected economic growth to 7 per cent this year, up from the previous expectations of 6.5 per cent.
Which-50 previously foreshadowed these changes when we wrote about the Fed’s likely pivot ahead of its annual Jackson Hole Symposium. In that piece, we noted that the inflation hawks had started to build the case for rate rises as early as 2022.
The effects of Powell’s statements should have businesses thinking about a normalisation of the cost of money. Rate rises will test everything, from cryptocurrencies through to project finance.
Take cryptocurrencies; the assumption has always been that cryptos would act as a hedge against inflation. Still, no one has yet factored in an environment where investors get paid to have bank deposits, bond holdings or other debt instruments in their portfolio.
As a result, the competitive landscape for investment dollars will move from a one-horse race to a truly multi-participant field.
Finally, everyone will have to contemplate a world where governments can no longer borrow at zero cost. Accumulated forward spending during the COVID pandemic has blown out deficits and exposed governments to rising interest rate bills.
If government spending shrinks as a proportion of the economy, what projects and services will suffer?