No Biggie: Inflation Jumping, Cut Rates Anyway

Let's do some quick math. The CPI's monthly inflation reported .3% for the last three months. Inflation currently is tracking above 3% in that time. The Fed's target is 2% inflation. I'm sure everybody learned in High School Fed class that when inflation's jumping you're supposed to what? Raise rates, right? Nope, this Fed is cutting rates. They don't care.

Let's Get Into It: CPI

Notice anything concerning here?

I do. Inflation has clearly picked up.

Are there any near term consequences of inflation picking up? Well, there happens to be a Fed meeting coming up next week. Do you think this Fed cares about a measly inflation number? They should, right?

But so far all they're signaling is for a rate cut at next week's meeting.

And Jobs: Jamming

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Jobless claims dropped to another low. That means people are working.

So the Fed for next week's meeting has inflation and jobs jamming higher.

I got an idea - fan the flames and cut rates. Good idea, right? Well, that's what they're planning.

Stock Market Pricing In Two Cuts This Year

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Above is what the market expects for Fed rates by year-end.

You get to Fed Funds by taking 100 - 98.32 = 1.68%.

The market is pricing in Fed Funds to reach 1.7% by year-end.

The Fed is currently at 2.125%.

Quick math. 2.125 - 1.68 = .445 or 50 basis points cut by year-end.

The meeting next week has been telegraphed. But with these inflation and jobs numbers, the Fed probably tries to temper the market not to expect another cut this year.

Dissents

The Fed release next week will show who voted for and against a cut. With these strong economic numbers, the Fed is nuts to cut rates. But they will do it anyway. But there may be a few more dissenters this time.

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Markets will be watching this one little blurb in the Fed statement. If the "voting against" list builds Fed Chair Powell is going to have a hard time selling markets on more rate cuts. He will have lost some support for pumping up this market.

Fanning The Flames Of Inflation

Rates are at record lows but inflation is moving up fast. Cutting now fans those inflation flames. The Fed thinks they are geniuses for fanning this flame. Why? Because inflation's been too low for too long.

The Fed also thinks they are geniuses by leaving that huge bond portfolio. That also fans the flames of inflation.

The world is as accommodative as it's ever been probably in the last few thousand years. I haven't been following the Fed that long but that's my guess.

So by dropping rates when the Fed already has cornered the bond market yet inflation is jumping, lookout. There's inflation risk.

And with inflation risk, guess what? Bonds don't like inflation. If bonds smell a whiff of inflation, they get creamed. If the market dynamics of low rates change very fast to jumping rates, then this market needs to revalue lower.

Markets are priced on future cash flows (earnings) divided by rates. Your denominator - rates jump then valuations go lower.

My Take

I see no way the Fed lets the market expect more rate cuts after Wednesday's meeting. If they do the markets will love it short term but they risk letting inflation out of the bag. And if they admit they need to cool off rate-cut expectations, I have to say the market won't like that next week.