Fed Likely to Use Blunt Tool, Powell Hints at More Pain to Come

To look at the stock market is to get the general impression that inflation is less of a threat than it was a couple of months ago, fears of a deep, hash recession are receding and the good times might soon return.

Maybe they are. After all, markets are about future earnings and conditions (and yes, fear and greed, too). But before everyone starts thinking it’s safe to go back in the water, we need to take a closer look at Federal Reserve Chairman Jerome Powell’s remarks on the Fed’s interest rate path.

Rates are going to go up – this month and in the months ahead. They won’t go up as quickly as they have since the summer. But rising they are. And rates will stay high for a lot longer than most traders seem to understand or are willing to admit. The reason? Inflation is still a problem:

There hasn’t been enough strong evidence to make a convincing case that inflation will soon decelerate, [Powell] said.

“It will take substantially more evidence to give comfort that inflation is actually declining,” he said. “The truth is that the path ahead for inflation remains highly uncertain.”

He added that “despite the tighter policy and slower growth over the past year, we have not seen clear progress on slowing inflation.”

Take those words to heart. Just because Wall Street is eager to have a Santa Claus rally doesn’t mean a lot of stockings won’t be filled with lumps of coal.

Powell said the “all clear” sign has not been lit. And won’t be until the data say otherwise:

“Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level,” Powell said.

“It is likely that restoring price stability will require holding policy at a restrictive level for some time. History cautions strongly against prematurely loosening policy,” he added. “We will stay the course until the job is done.”

We all like feel-good stories at Christmas time. And perhaps, just perhaps, that story this time is interest rates won’t become punitive in order to tame galloping inflation.

Let’s hope so. Inflation is destructive and interest rates are blunt tools that can inflict substantial collateral damage.  But as always…don’t buy the hype. And most of all, let the buyer beware.