What does the latest CPI index released by the Federal Reserve mean ?
Last Thursday, the US government released the January CPI (Consumer Price Index). In January, CPI rose by 7.5% year-on-year, reaching the highest point in 40 years in the United States. This is the ninth consecutive month that the CPI of the United States has increased by more than 5%, and the increase is still accelerating. Due to the soaring inflation, the capital market worried that the Federal Reserve would adopt a more aggressive policy of raising interest rates to curb inflation, and the three major US stock indexes fell on the same day. What makes the capital market even more panic is that on the second day after the CPI data was released, the Federal Reserve issued an urgent notice, and they decided to hold a closed-door meeting on February 14th to discuss the interest rate. According to the normal rhythm of the Federal Reserve, the meeting to adjust interest rates should be held in March. Before that, it was generally predicted by the market that even if it was necessary to raise interest rates, it would have to wait until this meeting was held in March, before which it was unlikely that interest rates would be raised temporarily. This time, the Federal Reserve announced a temporary closed-door meeting. Although this kind of operation is not uncommon, at this sensitive time node, it is considered by the market to be sending a major signal: it is necessary to raise interest rates urgently.
Investment institutions, including Goldman Sachs and Bank of America, predict that the Federal Reserve will raise interest rates seven times this year, each time by at least 25 basis points, and in March it may raise interest rates by 50 basis points at a time. One basis point is 0.01%, and 50 basis points is 0.5%. For example, the current discount rate of the Federal Reserve is 0.25%. If the interest rate is raised by 50 basis points, it will be raised from 0.25% to 0.75%. Now the global capital markets are holding their breath, waiting for the news of the Fed’s interest rate hike to fall.
The Fed’s interest rate hike seems to be menacing. However, even according to the market’s most pessimistic estimate, the Fed will raise interest rates by 200 basis points seven times in a year, which means that the current benchmark interest rate will be raised from near zero to 2%. Although it looks like a big increase, the absolute level of interest rate is not very high. We should know that the benchmark interest rate of many central banks in developing countries is as high as 10%.
In addition, the pace of the Fed’s interest rate hike is quite special. The last round of the Fed’s interest rate hike cycle was from 2015 to 2018. It took three years to raise the benchmark interest rate to 2.5%, but by the end of 2019, it had dropped to near zero interest rate. The last round of the Fed’s interest rate hike cycle was from 2004 to 2007, and it took the Fed three years to raise the benchmark interest rate to 5.25%, but as soon as the subprime mortgage crisis came, it fell to close to zero by the end of 2008. In other words, the rhythm of the Federal Reserve is that when raising interest rates, climb the hill carefully and climb the hill a little, and when cutting interest rates, step on the accelerator to the end.
In fact, raising interest rates is a last resort of the Federal Reserve, which is necessary to control inflation and bubbles. The interest rate cut is the real goal of the Federal Reserve, and the zero interest rate and negative interest rate are in line with the maximization of American self-interest. In recent years, the national debt of the United States has become larger and larger, but the magic is that in the long run, the annual interest paid by it has not increased, because the long-term interest rate has been going down. On the other hand, the huge debt scale also limits the rate of interest increase of the Federal Reserve. The interest rate is too high, and the US government can’t stand paying the debt interest alone. Some market participants estimate that the federal benchmark interest rate of 2.5% is already the affordable upper limit based on the current debt scale and fiscal revenue of the US federal government. Moreover, it is widely expected that the Fed will not only raise interest rates sharply this year, but also shrink its table, which is the reverse operation of quantitative easing, or “quantitative tightening”. It should be said that this prediction is also in line with our “common sense”: unlimited quantitative easing is a kind of “stress reaction”, and it is certainly impossible to last forever.
By Demi Zhang
