The Fed raising rates as the inflation running hot?

June 3, 2021 at 03:25 AM

The manufacturing sector has been highly pressured by the recent inflation created by the high commodities prices, when most industrial and grain commodities have moved vertically.

As the Chicago Business Barometer states, the factory gate prices just hit a 41-year high. In other words, the last time inflation was this high in 1980. That happened when the Federal Reserve (Fed) was forced to raise rates to over 15% and was one of the worst inflationary storms in history.

Slowing manufacturing, rising prices

So back in March 1983 the ISM Manufacturing was at its highest, but there was still hope for a small improvement for the April. Despite these hopeful expectations the ISM dropped from 64.7 to 60.7 – even as prices paid increased further. The prices paid subindex – i.e, the inflation component – rose for the eleventh month and now stands at June 2008 levels. Back then oil was way above 120 USD, nearing its peak, while the US 10-year yield stood at 4. 

As manufacturers and suppliers face significant price pressures 0%, we can expect the retail prices of the goods in the Consumer Price Index (CPI) basket to rise over the next few months. This may result in the inflation way above 3%. Based on this, the investors would assume that strong price pressures should lead the Fed to tighten monetary policy.

Will the Fed raise rates?

When the central bank raises rates usually it is a bad sign for small companies with weaker balance sheets. Basically, they will need to pay more to survive in business. However, the largest companies may also be affected in case the rate goes up again. As bond prices drop, bond yields will surge, destroying bond investors. This situation has been happening since the summer of 2020. The economic activity usually contracts or slows down notably in the high-yield environment. It is expected that higher rates may lead to disinflationary pressures, but like with everything, it will take some considerable time for the real impact to show up. 

With all the mentioned facts we can conclude that the Fed can’t raise rates and can’t taper its Quantitative Easing (QE) program. Otherwise, it could lead to a significant correction in the stock markets and the slowdown of an already fragile economy. And unfortunately, this might not end well, as the Fed simply doesn’t see a way around this situation and is trapped in it.

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