Financial tightening conditions and inflation

Aggression in Fed policy… The 10-year yields after the FOMC showed that the general approach remained on the side of persistent tightening, which activated the movement above 3% in the 10-year yields as well, since the breakdown in inflation and subsequent Fed guidance revealed that there was a longer problem than expected. Powell said financial conditions need to tighten to help the Fed restore price stability. The tightening in financial conditions is also becoming more evident as FOMC members signal that the committee will become more aggressive in tackling inflation.

US 10-year bond yields and historical correlation comparison of S&P 500 index. Source: Bloomberg

Protection against inflation… Many G7 countries expect serious increases in inflation. It should be taken into account that inflation will rise to undesirable levels in a possible energy and food supply crisis. This time, inflation is not an easy phenomenon to overcome without rectifying the defect in the structure, because there is no continuous improvement in supply chains and related supply conditions. With workarounds, you may be avoiding an item of the problem, but not the actual problem.

For the situation in bond yields, it is necessary to look at the economy’s exposure to the crisis and the expectations about inflation. These two facts directly affect the credibility and naturally the borrowing costs. When borrowing costs increase, companies’ financing costs increase and their valuations decrease. However, when the crisis phenomenon becomes active, this relationship brings with it the situation that bond yields fall with the demand for safe investments. For example, there is a very important externality; Like the current rise in oil prices, for example. The recession concerns brought about by this form the infrastructure of demand in the bond market. As there is significant economic uncertainty at the moment, investing in stocks involves more risk.

It is necessary to analyze the source of inflation well. Therefore, when inflation starts to decline, it will be necessary to analyze the source of disinflation similarly. Are prices falling due to a lack of demand, is this lack of demand due to decreased spending, profits, and economic recession, or is it because the dynamics that derailed inflation have improved? The Fed had the aim of increasing inflation, not reducing it in 2016 and 2019, and they did not experience excessively high inflation. Currently, inflation and recession problems are in a situation to be experienced together.

Conclusion? Although the Fed has stepped back from its tightening plans in similar periods when financial conditions were rapidly tightening, inflation today does not offer such a luxury. The recovery in the monthly core inflation rate in the April CPI report underlined that it would not be quick or easy to rein in inflation. It is also much more likely to remain hawkish for policy laid out for at least the next few months, as the Fed has been slow to understand the severity and persistence of the current inflation wave.

Kaynak Tera Yatırım
Hibya Haber Ajansı