In the science fiction fantasy comedy, three parapsychologists in New York go on the hunt for ghosts. It is not known whether Jerome Powell Fan is a fan of the cult film – or whether he at least sees parallels between his work and the activities of the main protagonists, among them Hollywood star Bill Murray. It’s certainly possible, given that the president of the US central bank has been operating as a sort of “ghostbuster” for some time now, in his case hunting down the spectre of inflation. As consumer prices went higher and higher last year, Powell launched an aggressive turnaround in interest rate policy. At the start of May, the Fed increased the base rate for the tenth time in a row. That means the Federal Funds Rate has climbed from close to zero to the current range of 5.00% to 5.25% within the space of just 14 months. Powell has never left any doubt as to how serious he is about pushing inflation down to the Fed’s 2% target level. “We will stay the course until the job is done,” is his credo.
The tighter monetary policy seems to be having an effect: in April the U.S. Consumer Price Index (CPI) exceeded the figure for the same month the previous year by 4.9%, indicating inflation in the world's largest economy had shrunk to its lowest level in two years. Graph 1 shows, however, that the deviation from the Fed's target level is still considerable. In the view of Mark Dittli, editor-in-chief of The Market, the US central bank will not go all the way down this path. “We would posit the theory that Powell will declare the war against inflation over in the course of the next few months,” the experienced economic journalist writes in his newsletter “The Big Picture”. Without stating it officially, Fed bosses could accept an inflation rate of between 3% and 5% as tolerable.
As usual, Dittli provides detailed reasons for this sensational assessment. He draws a line from the new banking crisis through the start of the US elections to the fight about increasing the debt limit. Should Democrats and Republicans not come to an agreement on this, the USA, according to treasury secretary Janet Yellen, threatens to become insolvent on 1 June. “This drama has the potential to unleash a wave of fear through the bond market in the summer and deliver a surge in bond yields,” Mark Dittli reckons. The USA’s rising interest burden was already becoming more and more the focus of public debate, and if the US central bank were to insist on hitting the 2% inflation target by hook or by crook in such an environment, this could have very negative consequences. As well as exacerbating the banking crisis, Dittli fears it could also lead to a severe recession. With that in mind, he expects the Fed to give way.
His theory is already being reflected in the price of gold and the US dollar exchange rate: the precious metal has climbed above the USD 2,000 barrier, while the greenback has spent most of the last few months under pressure. Meanwhile, the equity markets rather lack direction, with a number of negative factors – inflation, monetary policy, geopolitics, the US debt dispute, the banking crisis – dampening the mood. This contrasts with the prospect of a loosening of monetary policy and robust corporate profits. On Wall Street, the latest reporting season at any rate is causing the consensus on earnings to be revised upwards. Analysts now generally agree that the members of the S&P 500 will see a moderate increase in their profits in 2023. In the coming year, the US profit driver is expected to rev things up significantly again (see graph 2).
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Source: Statista; as at: May 2023 Past performance is not a reliable indicator of future performance.
e = expected (analyst consensus) Source: Factset; as at: May 2023 Past performance is not a reliable indicator of future performance.