November 01: Elevated inflation in the United States remains a key concern for financial markets in particular, because this incentivizes the Federal Reserve to take drastic action. The central bank has a policy of price stability and wants to bring inflation down to 2%. 

While at the beginning of the year, hopes were that inflation would ease down as economic activity recuperates, things have changed and the probability of a soft landing diminished. Even the FED acknowledged that more pain lies ahead, as interest rates are now at levels not seen since the 2008 financial crisis. 

Current path of policy

The latest inflation figures were not encouraging at all, with core US inflation rising to a 40-year high, securing another big interest rate hike at the November meeting. Market participants are now beginning to question whether the FED will be forced to take even more aggressive steps.

Signs of global economic slowdown can already be seen, considering the rise of the US Dollar always puts pressure on emerging markets, all of which rely on debt denominated in foreign currency. The tightening has been aggressive, but implications are only felt with a lag of at least several months. 

New upward revisions at the November meeting

Considering inflation remains sticky, markets will be focused on the FED’s reaction function. The last couple of meetings saw the governing council getting increasingly hawkish, as inflation surprised on the upside. 

It is still uncertain whether more upward revisions regarding the future path of interest rate hikes will be communicated at the November meeting. The experts at Easymarkets explain that this is because there is still more data that is supposed to be published by then, and that has to be taken into consideration.

FOMC members are also considering the various developments in the labor markets, where tightness continues even up to this day. A 75 bp hike is already priced in for November, so now the uncertainty deals with how the FED views things heading into 2023. Projections changed from one meeting to another, and any sign of more aggressive tightening can impact market psychology. 

Implications for financial assets

Assets such as stocks and cryptocurrencies did not perform well as interest rates rose. The diminishing liquidity puts downward pressure on risky assets, and things could get even worse, in case earnings estimates are revised downward – and that is not a scenario that should be underestimated. 

On the other side, the US Dollar leads in the currency space, benefiting from inflows. Investors want to stay in cash and view USD as a safe-haven during this time of elevated uncertainty. The trend is not expected to reverse until the FED signals a pivot, or inflation comes down in a meaningful way toward the target. Is either of those going to happen in 2023? It is way too early to tell.

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