Donald Trump has sworn in Kevin Warsh as the new chair of the US Federal Reserve, replacing Jerome Powell, in what was supposed to be the big monetary policy event of the year. Kevin Warsh, like all of Trump's preferred candidates for the Fed's board of governors, has sounded very keen to cut interest rates. Assuming that he was not simply paying lip service to the president's wishes in order to win the nomination, that would mean huge pressure in the Fed for aggressive easing. Yet it is no longer so clear that the change of chair will matter much.

The Middle East crisis has changed the calculation. Markets are now pricing in interest-rate rises rather than cuts, while longer-term bond yields are rising again. Of course, a central bank that is determined to slash short-term interest rates could ignore fears about inflation and cut regardless. It could also try to control long-term yields by buying up longer-dated bonds. But in this environment, it is far less likely that Trump's appointees will be able to shift consensus among other board members towards much looser policy. Nor is it obvious from his own record that Kevin Warsh will be quite so dovish for now, notwithstanding his frequently expressed view that AI will usher in productivity gains that justify structurally lower rates.

Interest rates are not Kevin Warsh's biggest problem

All else being equal, easier policy would have been even more bullish for already-exuberant stock markets, especially in the US. Yet investors have not been behaving as if policy was too restrictive anyway.

Note how strongly markets have risen with interest rates where they are. Short-term rates at around 4% and longer-term rates at around 5% only look high by the abnormal standards of the 2010s.

So the real risk to markets is not that interest-rate cuts don't come. Instead, it is the hard reality of where fears about inflation are coming from: the disruption to energy supplies. Every week, markets trade as if the crisis will be resolved; every week, we see no solid progress. If this finally starts to catch up with the real economy – which could happen in early June, some analysts reckon – the Fed's decision to tinker or not to tinker will quickly become irrelevant.

A date for your diary

The first of the twice-yearly Mello conferences for private investors takes place next month, on Tuesday 2 and Wednesday 3 June in West London. This event always features an interesting line-up of several dozen companies and funds presenting to existing and prospective investors: one of the highlights in last November's event was Seraphim Space, which has been the star of the investment-trust sector this year. Mello is offering MoneyWeek's readers a 25% discount on tickets – go to melloevents.com/mello2026 and use the code M26MW25 to book.

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Donald Trump has picked Kevin Warsh as the new chairman of the Federal Reserve, the US central bank, after months of very public arguments. The markets liked the choice. Equities rose on the news and gold tumbled as investors decided they no longer needed to hedge against the collapse of the dollar. Warsh is an experienced banker and policy-maker, but he is also close to the Trump circle, and in the past has advocated bold reforms of the way monetary policy is set. Given that Trump could easily have appointed Elon Musk, or one of his children, or even Melania, Warsh is seen as a relatively safe pair of hands.

Still, the challenges Warsh faces are daunting. First, he will have to re-establish the independence of the central bank. Trump has very clearly been trying to bring the Fed under political control, pushing it to cut interest rates even though it is far from certain that inflation is not going to start rising again. The incumbent, Jerome Powell, is facing legal action for overspending on the Fed’s new headquarters. The markets are not going to trust a Trump stooge and especially one who looks willing to start printing money to finance the president’s lavish spending and tax cuts. At some point, Kevin Warsh will have to make it clear that he is in charge, not the president. If he doesn’t, and if he seems to be conceding to Trump’s demand to juice the economy, especially ahead of the mid-term elections due later this year, the sell-off of the dollar, and Treasury bills, will start up all over again, and perhaps more savagely.

Next, Warsh needs to persuade both the White House and Congress that the deficit genuinely matters. The US economy is in robust health, but the budget deficit is still running at more than 5% of GDP and there are no plans to bring it under control. The US state has become addicted to borrowing to finance its spending. The last president to actually balance the books was Bill Clinton at the start of the century. The US has managed to get away with it so far, racking up bigger and bigger debts with every year that passes. But it has benefited from its reserve currency status, and it has been able to mop up huge amounts of Chinese savings. None of that will necessarily last forever. Warsh needs to find a way of getting the Senate, Congress and White House to control spending and, if necessary, raise taxes. The US can’t run deficits forever without risking ruinous inflation.

Thirdly, the new Fed chair needs to reinvent the dollar for a post-globalisation world. Trump has made it clear he does not want the US to finance the global trading system, that he is determined to bring free trade under control, and he wants to put America first. That is why he has ripped up the free-trade consensus and imposed the steepest tariffs since the 1930s. Whether the dollar can remain the global reserve currency in those circumstances is far from clear. Indeed, there is already evidence that central banks around the world are diversifying into gold and even bitcoin. The European Central Bank is too weak to influence anything, but China is carving out a global role for the yuan, and that is only going to grow in significance. What is the role of the Fed in all of that? Warsh will need answers, or else be left floundering as the world changes around him.

Kevin Warsh will need to calm the AI bubble

Finally, Kevin Warsh needs to calm an AI and tech bubble that has run out of control. AI is clearly a major new technology, and will create huge business opportunities, but it is also clear that investors have driven valuations far too high, just as they did at the height of the first internet boom a quarter of a century ago. Likewise, a handful of leading tech stocks have dominated the global markets. Sure, it will be great for the US economy that so much money is invested in the technology, with more than $100 billion poured into data centres and start-ups over the last year. It will pay off eventually in terms of new products and higher productivity, and it is a lot more impressive than anything that is happening in Europe. Even so, a crash will derail that, and once it starts may easily run out of control. The trick for Warsh will be to curb what one of his predecessors, Alan Greenspan, described as “irrational exuberance” without the entire market collapsing. It will not be easy. But he will have to try all the same. If the bubble carries on for another year, it will be too late.

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It is a bizarre legal action. Jerome Powell, the chairman of the Federal Reserve, the US central bank, has been prosecuted over renovations of the Fed’s headquarters and may now face criminal charges. Given that it manages an economy worth $30trillion and the world’s reserve currency, it is hard to see that the $2.5billion spent on improving the Fed’s offices really matters much. Even so, Donald Trump has clearly decided to use it as a weapon for a full-scale assault on a Fed chairman he would prefer to get rid of.

Powell himself was clear that the legal attack was just a way of bringing the Fed to heel. “The threat of criminal charges is a consequence of the Federal Reserve setting interest rates based on our best assessment of what will serve the public, rather than following the preference of the president,” he said in a statement. In other words, it is a political attack on the Fed and an attempt to allow the president to control monetary policy. If Powell is removed from office by the courts, whoever is appointed to replace him will clearly be taking instructions directly from the White House.

That is a dramatic and dangerous development. This is not to deny that independent central banks are worthy of criticism. Over the past 30 years, they have become too powerful, too confident in their own abilities and too quick to print money. You can make a case that, instead of ensuring greater stability, which is what they were meant to do, independent banks have inflated a series of asset bubbles, indulged spendthrift politicians and prioritised trendy causes while allowing industry to be hollowed out. There is a case for reform. Still, there is a big difference between that and a power grab to hand the right to set rates to the White House.

There are two big problems with that. First, it looks as if Trump is determined to control interest rates himself, either directly, or else through a tame proxy at the Fed. That is not without precedent. In Britain, interest rates used to be set by the chancellor, but the result was that the UK had one of the worst records on inflation in the world before Gordon Brown made the Bank of England independent in 1997. And it is hard to think of a worse person to set rates than Trump. He is temperamental, he constantly changes his mind, he doesn’t listen to advice, and his falling approval ratings mean he will constantly try to cut rates to boost short-term demand. Even more seriously, if the president acquires the right to set rates, it’s hard to see how it will ever be given up. It is too major a power to surrender. The US will have a politicised monetary policy permanently.

How bad will it get under Trump?

Everything else the president is doing appears designed to stop the free market working and drive up prices. The US has already imposed the steepest tariffs since the 1930s, with an average levy on imports of 18%. Closing off its markets to global competition will only drive prices higher and quality down. Only last weekend, Trump promised to cap credit-card interest at 10%, the kind of populist policy you would expect from the far left. Trump has also started capping corporate investment in the housing market. He is directing the oil companies to invest in Venezuela regardless of whether there is an investment case for it or not (with oil at $50 a barrel, there probably isn’t). There does not appear to be a coherent plan, but a whole series of interventions to create markets rigged by the government. State-controlled economies always end up with higher prices.

Add it all up, and one thing is clear – sooner or later the US will see a major rise in inflation. How bad will it get? There is no way of knowing for certain, and it will depend on what else is happening in the global economy. But once prices start to rise we know they are very hard to bring under control again. And if US prices rise, that will drive global prices higher. We can expect inflation to spread to Britain and the rest of Europe very quickly. Investors are already positioning themselves for that, with the price of gold hitting record highs every week. Prices of defensive assets will inevitably go a lot higher.

Over the past couple of weeks, we have seen unusually open debates and divergent views about the path of short-term interest rates among the committee members of the US Federal Reserve (the Fed) and the Bank of England (BoE). Professional Fed watchers are in a spin. What is the problem all of a sudden? And why is the debate happening so publicly? Where is the certainty previously displayed by these policymakers, always confident that they can control inflation via the setting of short-term interest rates? All is not right in the rarefied world of central banking.

The cornerstone of monetary policy in recent decades has been the perceived independence of central banks from political influence. The idea was that we could trust politicians more if our monetary policy was set and executed by an independent technocratic committee of experts acting in the public interest. UK gilt investors welcomed this initiative in 1997 when Gordon Brown granted the Bank operational independence.

But things have changed. The UK electorate has grown to distrust its politicians and its institutions. The British Social Attitudes Survey in 2000 showed that 35%-40% of adults believed that the government would put the country’s interests first. Last year, the same measure was 9%-14%, with 58% saying that they rarely trusted politicians to tell the truth.

The hard truth is that a central bank cannot function without government funding and authority, and cannot be genuinely independent. Most bond investors understand this; however, it has, until recently, been what we might call uncommon knowledge. Things have changed, and the notion of central-bank independence is being openly questioned – primarily in the US, but also increasingly in the UK.

Fiscal dominance

Donald Trump lives in the public domain. He became a household name via reality TV and conducts public policy via social media. Conventionally, it’s thought that like sausages, government policies are better not seen being made. However, Trump does things differently and since April, has variously referred to his Chair of the Federal Reserve on Truth Social as “Jerome ‘Too Late’ Powell”; “Too Angry, Too Stupid, & Too Political”; “TOTAL LOSER”; “A FOOL”; “Stubborn MORON”; “and “the Worst”.

From a political perspective, what the electorate is witnessing might be the consequence of trying to divert public attention, maybe from the bombing of Iran or the contents of the “Epstein files”. However, the underlying economic driver here is what economists call fiscal dominance. As Ray Bourne, of the Cato Institute, puts it: “Under fiscal dominance, monetary and financial policies get subordinated to support the government’s financing needs, with more tolerance for high inflation... long-term, the graver danger to central bank autonomy isn’t Trump’s tweeting – it’s US politicians’ borrowing.”

In short, beyond the event horizon of out-of-control sovereign debt, accepted rules and market correlations stop functioning. Just like in a black hole where the accepted laws of physics no longer apply, so too in a world of fiscal black holes, the accepted norms of central banking monetary policy stop working. For context, the US federal deficit has increased by $1 trillion, or 2.8%, since the passage of the “big beautiful bill”, and the raising of the debt ceiling last month, and now stands at $37.2 trillion.

The annual campout for the world’s under-siege central bankers in Jackson Hole later this month can’t come soon enough. This year’s theme is “Labour Markets in Transition: Demographics, Productivity, and Macroeconomic Policy”. But between official proceedings, time will be found to discuss the real agenda occupying them: how do we remain independent, or at least appear to be independent, and how can we pretend inflation targeting is even possible in a fiscally dominant world?

While Trump overtly undermines, insults and publicly humiliates his Fed chairman, in the UK, we do things more subtly. This week, both Keir Starmer and Rachel Reeves claimed the Bank’s ambiguous “hawkish cut” decision to lower UK policy rates as evidence of their successful stewardship of the UK economy. It was, they said, all part of their orchestrated plan to put the UK on a more secure economic footing.

Aside from the (lack of) independence point, there are two issues here. First, market interest rates that set the government’s cost of borrowing rose sharply following the BoE decision. UK gilt yields from one-year to 30 years’ duration rose as the bond vigilantes sharpened their axes. Second, the BoE’s governor, Andrew Bailey, said with a straight face that he thought that they needed to cut rates even though he expects inflation to “temporarily increase” to 4% next month. Is this the same as transitory? Note that the UK’s inflation rate has been above target in 48 out of the last 50 months. Sure, the world is getting riskier, but their models are no longer fit for purpose in a fiscally dominant world, nor are their proponents.

The pretence under which the Fed and BoE operate is becoming too obvious to ignore. Their work is increasingly conflicted with their fiscally irresponsible political masters, who can no longer afford for their independent monetary experts to achieve their mandates. So say goodbye to the era of central bank orthodoxy and hello to the new era of central bank dependency. There’s a new boss in town with different ideas. As they might say in Wyoming, inflation ain’t going nowhere. There’s a new sheriff in town, and he kinda likes it.

A version of this article was first published by wealth management group Dowgate Wealth.

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It is no secret that US president Donald Trump is not a fan of Jerome “Jay” Powell, the chairman of the US Federal Reserve (Fed). Last Thursday, 17 April, he took his criticism up a notch when he threatened to fire Powell, saying his “termination” could not come “fast enough”.

The move constituted a significant overstep. The Fed is independent, meaning it sets interest rates without interference from the White House or Congress. Politicians generally respect this.

The main thing irking Trump is Powell’s refusal to lower interest rates quickly. On the campaign trail, Trump promised to relieve pressure on households by reducing borrowing costs – a decision that lies outside of the president’s power.

Markets responded negatively to Trump’s comments when they opened after the Easter weekend. The S&P 500 closed 2.4% lower on Monday, while the Nasdaq 100 fell 2.5%. The dollar also weakened, while gold and long-term Treasury yields rose.

Trump quickly backtracked on Tuesday, 22 April, telling reporters that he has “no intention” of firing Powell. “I would like to see him be a little more active in terms of his idea to lower interest rates,” he added. Markets jumped on the news.

As well as Trump’s comments on Powell, the rebound was partly driven by the suggestion that the US might come to an agreement with China, after Treasury secretary Scott Bessent said the trade war was unsustainable.

“These comments have given markets a sense of optimism that recent chaos might have peaked and we’re heading towards calmer waters. It almost suggests that someone has taken Trump to one side and told him it’s time to be more responsible with his words and actions,” said Russ Mould, investment director at AJ Bell.

While a temporary sense of calm has been restored, the episode raises questions about the Fed’s independence and how much power the president has over the US central bank. Can Trump fire Powell – and what would it mean for markets?

Can Trump fire the chair of the Fed?

The chairman of the US Federal Reserve is nominated by the US president and confirmed by the Senate, however it is an independent role. The chair serves a four-year term and can be reappointed several times.

Powell was originally nominated by Trump in 2017 during his first term as president, before relations between the two soured. He was nominated for a second term by Biden in 2022.

Speaking in Chicago last week, Powell said the Fed’s independence is “very widely understood and supported in Washington and in Congress where it really matters”. He added that the central bank was “never going to be influenced” by political pressure. “We will only make our decisions based on our best thinking… our best analysis of the data.”

Despite this, lawyers recently told the Supreme Court that the Fed’s independence could be left vulnerable, should Trump’s recent firing of two Democrats be allowed to stand. Cathy Harris and Gwynne Wilcox were dismissed from two federal labour boards before their terms expired.

The implication is that this could set a dangerous precedent for other independent agencies.

What’s behind Trump’s criticism of Powell?

Trump’s argument with Powell goes back to the fact that he wants interest rates to fall more quickly.

The Fed has cut interest rates three times from their peak, bringing the federal funds rate to a range of 4.25-4.5%. The first cut was a large one at 50 basis points (September), with two 25 basis-point cuts after that (August and December).

At the latest rate-setting meeting in March, Powell suggested two more 25 basis-point cuts could be in store this year, however he also pointed to “heightened uncertainty” in the US economy, driven by the Trump administration.

“The new administration is in the process of implementing significant policy changes in four distinct areas: trade, immigration, fiscal policy, and regulation. It is the net effect of these policy changes that will matter for the economy and for the path of monetary policy,” he said.

“While there have been recent developments in some of these areas, especially trade policy, uncertainty around the changes and their effects on the economic outlook is high.”

Writing on his social media platform Truth Social on Thursday, Trump said: “The [European Central Bank] is expected to cut interest rates for the 7th time, and yet, ‘Too Late’ Jerome Powell of the Fed, who is always TOO LATE AND WRONG, yesterday issued a report which was another, and typical, complete ‘mess!’

“Oil prices are down, groceries (even eggs!) are down, and the USA is getting RICH ON TARIFFS. Too Late should have lowered Interest Rates, like the ECB, long ago, but he should certainly lower them now.”

Most economists disagree with Trump’s argument that tariffs will make Americans “rich”. Tariffs are essentially an import tax, paid by businesses and passed on to consumers in the form of higher prices.

If US inflation rises as a result of Trump’s trade policy, it could delay further interest rate cuts rather than opening the door to them.

The alternative scenario is that tariffs prove so damaging to economic growth that the Fed is forced to cut rates to support the economy – but for the wrong reasons (recessionary risks) rather than the right ones (slowing inflation).

In its latest economic outlook, the International Monetary Fund (IMF) has projected a “significant slowdown” in the US economy. It now expects growth to come in at 1.8% in 2025, down from its previous forecast of 2.7%.

While the institution is not currently forecasting a recession, it says the risk of one occurring has increased from odds of 25% to around 40%.

Why does central bank independence matter?

The Fed has a dual mandate – to promote maximum employment and price stability. To successfully achieve this, it needs to take a view that is both long-term and impartial.

Squashing inflation out of the economy, for example, has involved painful decisions. Many households and businesses are still struggling to pay off mortgages and debts as a result of higher interest rates. Someone courting public opinion may have struggled to make the necessary moves.

“The critical thing is to make sure that inflation expectations remain anchored; that everyone remains convinced that central banks will do what is necessary to bring inflation back to central bank targets in an orderly manner,” said Pierre-Olivier Gourinchas, economic counsellor at the IMF.

“Central banks have the instruments to do this. They have their interest rate instruments. They have various instruments of monetary policy. But one critical aspect of what they do comes from their credibility. So central banks need to remain credible. And part of that credibility is built upon central bank independence.”

What do Trump’s threats mean for investors?

Any threats to central bank independence are bad news for investors and the wider US economy.

Firstly, interference from the president would damage central bank credibility, adding to the risk of persistently higher inflation and therefore interest rates. In other words, Trump could end up undermining his own objectives.

Furthermore, lower short-term interest rates would probably come at the expense of a jump in longer-term Treasury yields, according to Samuel Tombs, chief US economist at Pantheon Macroeconomics. He points out that these matter more for the real economy.

Tombs suggests investors would “bake in a greater risk premium”, anticipating “more inflation and hence the need for tighter monetary policy in the future”.

Meanwhile, “higher corporate bond yields and lower stock prices would make financing more, rather than less, expensive for many private companies, offset only in part by the boost to exports from a weaker dollar”.

Monday’s “ugly moves” in financial markets are just “a taste of what would follow if Trump aggressively attacked the Fed’s independence”, according to Tombs. Investors will be breathing a sigh of relief now that Trump has backed down – and hoping he stays there.

The interest rate hiking cycle has ended - or that’s what it looks like anyway following the latest decisions from the European Central Bank, Bank of England and Federal Reserve. 

In the past week, all of these central banks have announced they’re pausing one of the most aggressive rate hiking cycles in the history of independent central banks. The BoE’s monetary policy committee (MPC) held the base rate at 5.25% at their meeting yesterday, the second meeting they’ve kept rates constant. 

Only the day before, the US Federal Open Market Committee voted to keep rates on hold for the second time, at a 22-year high of 5.25-5.50% (unlike the BoE, the Fed sets a range for its Fed Funds rate). And last week, the ECB held rates at 4%. 

All three of these leading central banks have hiked rates from zero over the past 18 months, as they’ve tried to bring inflation under control.  

Inflation begins to fall  

So far, the medicine seems to be working. Eurozone inflation dropped to a two-year low in October of 2.9%, from 4.3% a month earlier. Meanwhile, inflation dropped to 3.7% in the US for the 12 months ended September. 

Here in the UK, inflation has proved tougher to control. Since CPI inflation reached 11.1% in October last year it has fallen by more than 4 percentage points, although it flatlined at 6.7% in September. Inflation has remained sticker in the UK due to the energy price cap, which works with a lag. 

Unlike the US and Eurozone, where lower energy prices have already filtered through to consumers and businesses, the price cap is preventing prices from falling as fast here in the UK.

As energy is a big component of the inflation figures, this is something policymakers will be taking into consideration when setting interest rates. 

Higher interest rates are starting to have an impact 

Inflation is just part of the equation for central bankers. While The Fed, BoE and ECB all have a mandate to keep inflation under control, they don’t want to crush their respective economies at the same time. So they have a tough balancing act to practise.

That said, coming off the pedal too early could reverse much of the progress they’ve already made in the fight against inflation. BoE governor Andrew Bailey has said rates must stay, “sufficiently restrictive for sufficiently long”. He’s also recently added, “It’s far too early to be thinking about rate cuts.” 

Across the pond, Fed chairman Jerome Powell has summarised the Fed’s stance as being “not confident we have reached sufficiently restrictive [financial conditions], but not confident we haven’t”.

The markets have a bit of a different view. The market is pricing in interest rate cuts starting in the second half of next year and is only assigning a slim chance to further rate increases from both the BoE and the Fed. 

There are signs on both sides of the pond higher rates are starting to have an impact on economic growth. In the UK in particular, activity in the construction sector has fallen off a cliff and consumers are pulling back on spending as higher interest rates bite. It’s also more appealing than it has been for over a decade to save rather than spend (one of the main reasons why interest rates are so effective at controlling prices). 

Higher interest rates mean it’s more expensive for companies and consumers to borrow money to spend and invest, which reduces demand, forcing businesses to lower their prices. While inflation remains high in the UK, shop price inflation has been falling, suggesting part of this equation is already playing out as businesses compete for customers’ shrinking spending power.  

An upcoming election  

The BoE will have this in mind when it’s thinking about interest rates going forward. If businesses have to fight for consumers' money, business activity in the economy will fall (as is already happening in the construction industry) and that could lead to a recession. Higher interest rates are already forcing the government, which relies of debt to fund the day-to-day running of essential services, to consider benefit and spending freezes. 

With an election coming up, the government may start putting pressure on the BoE to cut rates, or at least hold off on any further rate increases to avoid sending the economy into a recession or driving harsh spending cuts in 2024. 

All in all, there’s a chance the BoE could push rates higher in the coming months if inflation surprises to the upside, but with risks to the economy growing, and inflation falling in the rest of the world, (which will filter through to the UK over time) the central bank may decide to hold off on any further changes or even cut in 2024. 

US inflation rose to 3.7% in August, driven by a sharp increase in energy prices and higher costs for rent.

The US inflation rate was 3.7% over the 12 months to August, the Labor Department said - up from 3.2% in July.

The year-over-year increase was slightly higher than economist forecasts of a 3.6% annual jump.

The price of energy commodities, including gas and oil, jumped up 10.5% over the last month. 

 Will the Fed raise interest rates? 

Despite the surprise inflation  rise, analysts do not expect the figures to complicate matters for the Federal Reserve as policymakers tend to focus on core inflation numbers, which strip out volatile food and energy prices.

“Inflation data from the US yesterday was mixed but there wasn’t anything in there to cause major alarm for either investors or the Federal Reserve, even if energy prices are starting to become a relevant inflationary pressure again,” says Russ Mould, AJ Bell’s investment director.

On a core basis, prices in August climbed 4.3% over last year — a slowdown from the 4.7% annual increase seen in July.

Within core inflation, rent prices surged. The index for rent and owners' equivalent rose 0.5% and 0.4% on a monthly basis, respectively. Owners' equivalent rent is the hypothetical rent a homeowner would pay.

"If you look at what’s going on underneath the surface, core inflation continues to gradually cool," says David Kelly, chief global strategist for J.P. Morgan Asset Management. "I don’t think people should look at it as some kind of revival of inflation pressure."

The data is unlikely to make the Federal Reserve raise interest rates at its next meeting but it could push it to act later in the year, says Jeffrey Cleveland, chief economist at Payden & Rygel.

Seema Shah, chief global strategist at Principal Asset Management, believes one more rate hike is still possible before the end of the year.

"The inflation print likely is not enough to tilt next week’s Fed call towards a hike, yet it also hasn’t entirely cleared up the question of a November pause vs. hike,” she says.

 What is the current interest rate in the US? 

The Fed has already raised its benchmark interest rate to the highest level in 22 years, targeting a range of 5.25% to 5.5%.

The Fed rate is a range because the Federal Reserve cannot mandate a set number.

Fed chairman Jerome Powell warned last August that inflation remained “too high".

"We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective," he said.

Like the Bank of England, the US Federal Reserve has a mandate to keep inflation at 2%.

The US central bank will meet to decide whether to or not to keep the rates unchanged at its September 20th policy meeting. 

The rate of inflation in the United States slowed to its lowest rate in two years in April, indicating the Federal Reserve’s efforts to lower prices by hiking interest rates might be starting to work.

The Consumer Price Index (CPI), which measures the cost of a basket of goods, rose 0.4% in April and 4.9% over the last 12 months, but this was a deceleration from 5% the month before. The latest CPI read suggests prices are rising at the slowest rate since April 2021.

Analysts widely expected the figure to remain at 5%, so the lower figure will come as a relief to the Federal Reserve. The central bank has been hiking interest rates over the last year in an attempt to curb rising prices.

What is driving inflation in the US?

The cost of housing also. Housing costs - the largest contributor to the headline figure - increased 0.4% following a 0.6% increase in March. Meanwhile, the energy index rose 0.6% in April, mostly due to an increase in the cost of petrol.

But the rate of inflation was driven down by falling airline fares, which dropped 2.6% over the month. Lower prices for new cars also helped pull down the headline number.

The rate of inflation peaked at 9.1% in the US last June, its highest level since 1981. Though it has since fallen steadily, it remains significantly above the Fed’s 2% target.

What does US inflation mean for interest rates?

Last week the Fed raised its key rate by 0.25%, taking it to a range of 5% to 5.25% – its highest level since 2007.

This marked the tenth consecutive increase in over a year, but Federal Reserve chair Jerome Powell indicated the Bank might be getting “closer” to stopping the rate hikes.

“The consensus is that the Fed's latest rate hike was certainly its last for this cycle, and the Fed will cut the rates by 75bp before the year ends,” says Ipek Ozkardeskaya, senior analyst at Swissquote Bank.

But a rate cut can’t be taken for granted just yet as inflation is still twice the Fed target rate.

On the other hand, the turmoil in the US banking sector “is tightening credit conditions and helping the Fed to do its job – restrict credit in a way to slow growth and ease inflation,” says Ozkardeskaya.

But core inflation is proving stickier, having stayed at 5.5% since the end of last year. “As a result, rate cuts towards the end of the year cannot be taken as a given, and much of it will depend on what the Fed does next,” says Richard Carter, head of fixed interest research at Quilter Cheviot.

“It will be hoping that the latest interest rate rise is enough and that this feeds into the economy in the next couple of months… The Fed will be keeping a close eye on events and as has been proven over the course of the last three years, nothing can be taken for granted. In the immediate term, a pause now seems on the cards, but beyond that remains as volatile as ever.”

US inflation seems to be accelerating again. According to the latest numbers, published today, CPI inflation across the country hit 6.4% in January, compared to the previous reading of 6.5% in December. Analysts and economists were projecting a rate of 6.2%.

What’s more, core inflation, the measure of inflation that strips out the volatile food and energy components, came in at 5.6% compared to expectations of 5.5%. The reading was 5.7% in December.

This figure suggests that inflation is becoming more embedded in the economy, and consumers, as well as businesses, are pushing up their prices to compensate for persistently higher costs.

What the latest US inflation data means for the economy

The January inflation report was highly anticipated by the market. The US Federal Reserve has been hiking interest rates to try and bring inflation under control recently. This has sparked concern that the central bank could cause the economy to grind to a halt, as it fights to get prices lower.

“We see ourselves as having a lot of work left to do,” Fed Chair Jerome Powell said earlier this month, suggesting the central bank is going to push interest rates higher throughout the rest of the year.

While this inflation report was worse (inflation was higher) than expected, it wasn’t terrible. After all, CPI inflation is still heading in the right direction, it's just not falling as fast as some analysts and economists might have expected.

As Chris Beauchamp, chief market analyst at IG Group says, “US inflation is still resolutely sticky, and it shows the Fed still has more to do. But the numbers were broadly in line with what markets had been expecting, and were certainly not enough to frighten the horses too much.”

This is good news for investors, but there could be further disruption to come. Even though inflation is starting to moderate, with food and energy prices coming off their one-year highs, it will take some time for higher interest rates to filter through to the underlying economy.

If economic growth begins to slow dramatically, then this could spook markets. On the other hand, if the economy remains stronger than expected, it could lead the Fed to push rates even higher, and that could hurt asset prices.

“The muted reaction should not be dismissed – inflation still has the power to scare, but this was not the reading to do it. If we get another barnstormer of a jobs number then markets will go back to fretting about more sustained inflation, but for now calm reigns,” notes Beauchamp.

The US Federal Reserve raised interest rates by 0.5%, taking the base rate to a 15-year high as part of its attempts to control rising inflation.

The benchmark interest rate now sits at a range of between 4.25% to 4.5%.

However, it looks as if the central bank is going to slow the pace of rate hikes going forward.

After announcing the rate change, Jerome Powell, chair of the Federal Reserve, said “the appropriate thing to do now is to move to a slower pace” and see how the economy responds to higher interest rates.

He also said the Fed expects inflation to remain high into next year. The US Bureau of Labor Statistics reported earlier this year that prices have risen by 7.1% from last November, increasing 0.1% from October.

The Fed’s interest rate announcement preceded the BoE’s interest rate hike of 0.5% as both central banks face the difficult task of controlling rising inflation without causing too much harm to their respective economies.

Why is the Federal Reserve raising interest rates?

While November’s 7.1% figure is an improvement from June’s 9.1% rate of inflation, which was the highest in 40 years, it’s still three times higher than the Fed’s target of 2%.

The Federal Reserve has been increasing rates at a fast pace as it looks to control inflation.

The easing figures in October were mostly due to falling gas prices. However, the cost of healthcare, rent, and dining out remains high with rent driving the cost of living up the most.

Increased interest rates make the cost of borrowing higher, which in turn encourages saving.

So in theory, they should help bring prices down as people spend less and businesses compete for custom by decreasing prices. But because they discourage spending, they also slow down the economy.

“Inflation has been falling since the summer when the rate peaked at the highest level in over 40 years, 9.1%, compared to yesterday’s 7.1% reading,” says Dan Boardman-Weston, CEO and chief investment officer at BRI Wealth Management.

“This seems to have given the Fed confidence to slow the pace of interest rate increases, even though rates are likely to rise to a higher level and remain there for longer than expected a few months ago.”

But Powell added that while the October and November figures were encouraging, “it will take substantially more evidence to give confidence inflation is on a sustained downward path”.

What do rising interest rates mean for you?

By hiking interest rates the Fed is making it more expensive to borrow money, which should reduce demand for goods and services.

For example, 30-year mortgage rates have spiked to 6.3% over the past year, pushing up the cost of buying a home. As a result, property prices have started to fall as buyers reconsider their options.

Still, with the Fed now expected to slow the pace of rate hikes going forward, borrowers could see rates fall as the market settles into the new normal. Indeed, the average 30-year mortgage rate hit a 20-year high of 7.08% in November, but, as noted above, the rate has now dropped back to 6.3%.

Unfortunately, it does not look as if the central bank will be cutting rates any time soon, suggesting the outlook for equities is going to remain uncertain.

Both the S&P 500 and the Nasdaq saw losses following the Fed’s decision, closing 0.60% and 0.80% lower respectively.

“We expect that higher rates will subdue economic activity in 2023 and that this will lead to corporate profits falling and equities remaining under some pressure,” says Boardman-Weston.

“It’s become clear this year that the Fed is intent on crushing inflation and future expectations of inflation. The higher interest rate environment required to tame inflation comes at the cost of economic growth, which likely comes at the cost of lower stock markets.”

The Bank of England has raised interest rates by 0.5%, which means the central bank’s base rate now stands at 3.5%, the highest level since October 2008.

This is the ninth consecutive increase in the base rate. Last month the bank’s Monetary Policy Committee (MPC), which sets interest rates, decided to raise rates by 0.75%, one of the steepest hikes of the last few decades as inflation surged.

The central bank has been hiking rates to try and control inflation, but policymakers are now worried that hiking rates too far too fast will hurt the economy and they’re starting to take their foot off the pedal.

A month ago analysts were expecting the MPC to hike rates by 0.75% at its December meeting. The slower pace of growth comes as UK GDP shrank by 0.3% in the three months to October and the chancellor warned we are in a recession.

Other central banks are also scaling back their fight against rising prices.

Yesterday the US Federal Reserve announced a rate hike of 0.5%, taking the base rate in the US to 4.5% its highest in 15 years. However, it also said it would be slowing down on its rate increases to see how the economy was responding.

And the European Central Bank has also slowed the pace of hiking. After the BoE announcement, it raised interest rates by 0.5% after a 0.75% jump at its last meeting.

All three banks remain committed to taming inflation while trying to minimise the collateral damage to their economies.

Why did the Bank of England increase interest rates?

While the headline inflation figure fell to 10.7% from 11.1% in November, UK inflation is still running at over five times the BoE’s 2% target.

Higher interest rates increase the cost of borrowing, In theory, this should put people off spending and encourage them to save decreasing demand. Businesses then have to compete for the remaining business usually by cutting prices.

That said, the BoE has admitted its aggressive stance against inflation might be hurting the economy by increasing costs for borrowers and reducing spending.

Additionally, inflation is being driven by factors outside of the BoE’s control.

Food and energy prices have shot up this year largely due to Russia’s invasion of Ukraine, which the central bank cannot control.

How much further will interest rates rise?

This month’s inflation figures would suggest inflation has peaked, and that could mean interest rates won’t rise much higher.

It certainly seems as if that’s the case in the US. After announcing a 0.5% rate hike yesterday, Jerome Powell, the Fed’s chairman, said that though there was still “some way to go” to control inflation, the bank wanted to slow down the pace of rate hikes to see how the economy was responding.

Back in the UK, a couple of months ago analysts were forecasting peak interest rates of nearly 6%, but now it seems they don’t expect the BoE to go much further than 4.25%.

“With fractionally moderating inflation, the looming threat of recession and a slight tick up this week in the unemployment rate, the Bank of England rightfully voted for a more cautious approach to tightening," noted Victoria Scholar, head of investment at interactive investor.

“The Bank of England can feel justified by its counterparts stateside that it made the right decision. Both the BoE and the Fed adopted the same approach, voting for a more dovish 50 basis point hike, having both raised rates by 75 basis points at their previous meetings," Scholar went on to add.

The minutes of the MPC meeting, released after the rate decision, showed that the bank's outlook for the economy is starting to pick up, albeit modestly.

"There was much to like within the minutes," noted Nicholas Hyett, an Investment Analyst at Wealth Club.

"The rising value of sterling is good for our buying power as a nation – taking some of the edge off international inflation. This, together with historic price rises rolling out of the data, mean headline inflation will fall substantially next year," Hyett added.

"That should help ease demands for wage increases, reducing the chances current inflation becomes endemic. Further good news came in the form of easing global supply pressures."

What do rising interest rates mean for you?

Rising interest rates mean higher borrowing costs. This is the case for all debt – loans, credit cards, and mortgages.

Mortgage rates have fallen from their peak of 6.65% in October, but they remain high compared to recent standards. According to Moneyfacts the best two-year fixed-rate mortgage now costs 4.7% compared to 2% this time last year.

Rising rates are particularly bad news for those whose fixed rates end in 2023 – UK Finance estimates this is the case for around 1.8 million homeowners.

As Alice Guy, Personal Finance Editor at interactive investor explained, "rates rises mean someone with a £200,000 tracker mortgage could be paying an extra £326 per month which is an eye-watering annual increase of £3,912."

The effect of rising rates, coupled with the rising cost of living, has already begun to affect the property market and prices are creeping down after two years of fast growth.

Rising rates are also good news for savers. Providers are not obligated to raise rates in line with inflation, and currently, there are no deals out there that come close to helping savers earn a real return on their money.

Still, higher interest rates have been trickling down to the best regular savings accounts, so it could be a good time to look for a better home for your savings.

“Higher interest rates do not always translate to higher savings rates. It could take months for the increase in interest rates to trickle through to savers – if at all. The acceleration in the frequency of rate rises has meant that some savings providers may still be catching up to past base rate rises. Put simply, you may get a better savings rate in the near future – but there are no guarantees. The amount you are looking to save could guide your decision. An uptick in savings rates could mean the difference between pennies and hundreds of pounds depending on how much you have to save," noted Myron Jobson, Senior Personal Finance analyst at interactive investor.

They have also had a positive impact on annuity rates. Rates have hit a 14-year high, breathing life back into a product that for years has been overlooked.

US inflation slowed in October.

The consumer price index rose 7.7% year on year in October, the smallest annual increase since the start of the year.

The figure is below the 8% forecast by economists and down from 8.2% last month.

This reading suggests inflation might have peaked, taking pressure off the Federal Reserve, America’s central bank, which has been trying to combat rising prices by hiking interest rates.

Currently, interest rates in the US sit at 4% after a 0.75% hike last week, their highest level since early 2008.

While Federal Reserve chair Jerome Powell has warned that rates will need to rise further to curtail inflation, the slowdown has ignited speculation the Fed will slow the pace of increases in the coming months.

Why did US inflation decrease?

A lower than expected rise in rent and housing costs was the main reason for the slowdown in US inflation last month.

That said, the property market in the US remains hot, so it could take some time before prices come down sustainably.

Car prices, costs for clothes, medical care and airline fares all declined. The price of food has also stopped rising as quickly as it was before and energy prices in the US have been lower than in Europe, as it’s far less reliant on foreign gas and oil.

However petrol prices did increase slightly, and restaurant prices and hotel rates also remain high.

UK inflation figures are due out 16 November, however the latest data from the Office for National Statistics showed today the economy shrank 0.2% as we head towards a recession.

How did the markets react?

Investors welcomed the figures, with share prices rising in the US, Europe and Asia.

The S&P 500 index rose 5.5% after the data was published, and the Nasdaq Composite index closed 7.4% higher.

Hong Kong’s Hang Seng index rose 5.5%, China’s CSI 300 index gained 1.9% and Tokyo’s Topix index 1.8%.

In Europe the Stoxx 600 gained 2.7%, while the FTSE 100 and the FTSE 250 gained 1% and 3.9% respectively.

The dollar fell 2.3%, while sterling jumped over three cents to $1.17.

The US Federal Reserve hiked interest rates by 0.75% for the fourth time in a row on Wednesday as the central bank continues its fight against inflation.

Following the hike, the federal funds rate, which sets the borrowing benchmark for everything from credit cards to trillions of dollars of financial derivatives that underpin the global financial system, stands at 3.75% to 4%.

However, it looks as if the central bank is going to adopt a more cautious approach when it comes to rate hikes going forward.

The Federal Reserve warns rate rises may slow

According to the central bank’s commentary published alongside the rate decision, it will now be taking into account how far rates have already risen this year, as well as taking into account the time it’ll take for increases to filter through into the real economy when setting rates in future.

Wall Street initially interpreted this statement as meaning that the bank will ease off on increasing rates going forward, but that view was soon squashed.

In a press conference after the rate change was announced, Federal Reserve chairman Jay Powell warned that the so-called “terminal” interest rate (the rate the Fed believes will be needed to tame inflation) will be higher than expected.

In other words, it looks as if the bank is prepared to push rates a lot higher to tame inflation.

Bringing inflation back down to target

The US central bank is aiming to get inflation down to its target of 2%.

By hiking interest rates, the theory is that consumers will look to save more money and businesses will slow spending. This should drive companies to lower prices as they fight over customers’ reduced spending power.

As of yet, it does not look as if higher rates are having the desired effect.

The US inflation rate hit 8.2% in the 12 months to the end of September, higher than forecast, although it was lower than the 8.3% recorded in August.

More importantly the measure of inflation that strips out the volatile food and energy components jumped to 6.6%, the fastest rate since 1982.

It’s this rate that’s worrying the Fed and economists. It means housing and medical costs are still rising and inflation is becoming entrenched in the economy.

That’ll make it harder to control as workers demand higher wages to compensate for increased costs.

What does the Federal Reserve’s war against inflation mean for you?

As the Fed hikes rates further, the cost of credit is rising. The most obvious market where this is having an impact is the mortgage market. The 30-year mortgage rate reached 7.08% last week. That’s the highest level since 2002.

The impact this will have on house buyers’ purchasing power, and as a result, the housing market, cannot be understated.

In December last year, when an average 30-year mortgage cost 3.11% the monthly repayments on a $300,000 would have been around $1,283. Today, the cost to buyers is $2,012 a month.

This suggests either house prices are going to fall, or those with mortgages are going to have to cut back on spending in other areas.

Elsewhere consumers are going to face higher borrowing costs and higher costs in general as companies will likely pass their higher interest costs onto consumers. These price hikes could only add fuel to the inflation fire.

On the other hand, as rates move higher the value of the dollar is surging. This will reduce the cost of imported goods and services and make it cheaper for American consumers travelling overseas.

Remember to get your tickets for the MoneyWeek Wealth Summit hosted by Merryn Somerset Webb, on 25 November 2022! – we’ve got some brilliant speakers lined up and, given everything that’s going on, we’ll have an awful lot to talk about.

Book your place now at moneyweekwealthsummit.co.uk

“The world has been hooked on cheap money for years. Now we’re witnessing what withdrawal looks like,” says Randall Forsyth in Barron’s.

Last week, central banks from Scandinavia to Mongolia and from South Africa to Indonesia raised interest rates. America’s Federal Reserve delivered its third successive three-quarter point interest-rate hike, while the Bank of England raised interest rates by half a percentage point to 2.25%. Switzerland became the last European central bank to end its experiment with negative interest rates, leaving Japan as the only big economy where rates are still below zero.

Markets have swooned, with America’s S&P 500 stock index falling to its lowest level of the year so far on Monday. Oil prices have hit their lowest level since January on expectations of weaker demand.

Bond-market pain

“We’re living through… the most truly global attempt to tighten financial conditions in memory,” says John Authers on Bloomberg. “With 2022 not quite three-quarters over, this is already the worst year for [US Treasury] bond investors in six decades.” The yield curve, a measure of the gap between yields on US ten-year and two-year government bonds, has reached its steepest inversion “in more than 40 years”. Previous inversions have heralded a recession.

It has been clear for some time that monetary policy would need to tighten, but traders are only slowly waking up to the implications for overpriced equities, says James Mackintosh in The Wall Street Journal. “Markets are doing what they always do, hoping against hope that there’s no recession, or at least a very mild one, right up to the last minute.”

Fed policymakers have made clear that more hikes are in the pipeline, says Aaron Back in the same paper. Fed chair Jerome Powell describes the US labour market as “extremely tight”, a sign that the economy is still running too hot. US central bankers want “to see the economy slow significantly, even if that involves some pain”. Yet the bulls may still have a point: “the inflation... Powell is contending with isn’t nearly as entrenched as that of the 1970s. So a recession isn’t a sure thing and, if there is one, it might not be very deep or prolonged by historical standards”.

Investors are struggling to accept that their lost wealth isn’t coming back any time soon, says Katie Martin in the Financial Times. “The five stages of grief are denial, anger, bargaining, depression and acceptance.” Markets spent much of the summer in bargaining mode, when they “briefly took seriously the notion that central bankers might be gentle with rate rises”.

The current mood in stocks is somewhere between depression and acceptance. The latest round of global rate rises “has demonstrated, as if it were not already obvious, that declines in asset market valuations are simply not going away”.

The annual conclave of central bankers at Jackson Hole, Wyoming, is usually only of interest to the nerdiest of market watchers and economists who relish the micro-analysis of the carefully scripted wording of speeches and press releases. But this year was different.

Having raised interest rates this year by 2.25% to a target range of 2.25%-2.5%, the Federal Reserve, America’s central bank, had been expected to “pivot” to a more dovish stance. This might mean that the 0.5% increase in September would be the last, or that the increase would be 0.25%, or that there would be no increase at all.

Instead, Jerome Powell, chair of the Federal Reserve, reiterated the need to bring inflation down by pushing up interest rates whether it caused economic pain to households and businesses or not.

Why the Fed has changed its mind on interest rates

What caused this apparent change of mind?

Not the rate of inflation, which fell from 9.1% in June to 8.5% in July while the core underlying rate fell to 5.9%. Inflation is expected to have fallen further in August and economic indicators point to a further fall in the coming months.

Instead, Powell appears to have reacted to the bond market. The yield on ten-year US Treasury bonds rose from 1.5% at the start of the year to a peak of 3.5% in mid June before falling to 2.6% at the end of July. Since then, it has risen to 3.1%, indicating that while bond yields may accept the current downward trend of inflation, they are not convinced that it will fall back to 2% and stay there.

The gap between inflation-protected and conventional bonds, regarded as a good indicator of inflation expectations over the next ten years, rose from 2.3% to 2.6% so the credibility of the Fed was at stake. The Federal Reserve, it now seems, is committed to a monetary policy that will satisfy the bond market.

The “bond vigilantes”, a term invented by economist and market analyst Ed Yardeni in the 1980s to describe a world in which bond investors drive monetary policy, are back.

It is notable that the 24% fall in the S&P 500 index between the start of the year and mid June, a period in which corporate earnings continued to rise at a brisk pace, coincided almost exactly with the rise in bond yields. So did the 17% rally to mid August, and so did the subsequent 8% fall.

Stockmarket investors are not particularly concerned about the effect any recession would have on corporate earnings because they know that corporate earnings will recover with the economy. They are much more concerned with the risk of higher bond yields, which result in lower interest rates.

If bond investors are happy, stockmarket investors are happy

This goes against conventional wisdom which claims that recessions are “bad” for stockmarkets, so markets will be undermined by higher rates. Investors want central banks to do whatever it takes to knock inflation back, regardless of the short term economic consequences. If bond investors are happy, stockmarket investors will be happy too, and the yield on ten-year US Treasuries is the best indicator of investor confidence.

Consumers and businesses do not like paying higher interest rates on their borrowings, but they like inflation even less. They do not want a recession with its attendant risk of unemployment and falling living standards but will probably accept some short term sacrifice if the result is lower inflation and interest rates, combined with a return to growth in the longer term. We are all inflation vigilantes now.

The reason US inflation is falling – and hence the economy is in good shape – is down to energy. Fracking has made the US self-sufficient in oil and gas, in addition to which the US is bordered by two hydrocarbon-rich friendly countries. Europe, in contrast, trusted its future energy needs to Russia, succumbing to anti-nuclear superstition and a Russian-backed campaign against fracking. There are few signs of policy change.

Britain lies somewhere in the middle with plenty of hydrocarbon reserves, but an aversion to exploiting them.

The UK seems intent on making the problem worse. The Bank of England has proved slow to raise interest rates with the result that sterling fell 5% in August alone. This promises to exacerbate inflation and worsen the outlook for the UK economy.

The government has the fiscal headroom to alleviate the downturn, but all the media and popular pressure is for short-term fixes which will make the problems worse.

The imperative is to reduce demand for hydrocarbons and increase supply, not to finance short-term hand-outs through borrowing and production taxes. We will soon see whether the new government will rise to the challenge.

The world follows where the US leads

Ed Yardeni notes that falls in US GDP in the first two quarters match the definition of recession but he expects the data to be revised upwards, helped by strong employment. He doesn’t “expect any downturn over the rest of the year and/or next will be severe enough to qualify as an official recession” but instead sees the continuation of a “rolling recession” passing through different sectors and regions.

As a result, he expects “S&P 500 earnings growth of -5.4% and -3.8% year-on-year in quarters three and four” which still means growth of 3.1% for the year as a whole and 9.3% next year.

That puts the S&P 500 on 18.4 times this year’s earnings and 16.9 times next. Whether that is cheap or expensive depends very much on the Federal Reserve dancing to the tune of the bond vigilantes. If it does so, US Treasuries may even be reasonable value.

The US accounts for 62% of the global stockmarket, while Japan, where inflation is just 2.5%, is also in good shape. The countries facing serious economic challenges, including the UK, the EU and China, make up less than 20% of the index. As the US goes, so will world markets.

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“Gone are the days [when] we could rely on a Powell-backed equity rally,” says Ipek Ozkardeskaya of Swissquote Bank. Stockmarkets are used to central bankers offering them goodies when the economy weakens, but last week US Federal Reserve chair Jerome Powell instead threatened to remove the punchbowl. He made clear that “inflation must come down even if it means pain for households and businesses”.

The annual “central bankers’ conclave” in Jackson Hole, Wyoming, sees the world’s most powerful monetary policymakers gather to share “the latest reading from their models, crystal balls or chicken intestines”, says Irwin Stelzer in The Sunday Times. In 2021 Powell declared at the meeting that high inflation “was likely to prove temporary”. What a difference a year makes. With US inflation at 8.5%, he will now do battle with the inflationary tiger. Markets tumbled after Powell’s speech, with the S&P 500 and Nasdaq Composite falling 3.4% and 3.9%.

Japan’s Nikkei slipped by 2.7%. US interest rates are currently between 2.25% and 2.5%. Markets now expect the Fed to raise rates to “3.8% by February 2023, up from expectations of 3.3%” at the beginning of August, says the Financial Times. Powell and other senior global central bankers pushed back strongly against market bets that they will start cutting rates next year, says Bloomberg. Instead, they “expect to raise rates and hold them at elevated levels” until inflation is back under control.

Learning from history

Powell was also at pains to dash hopes that July’s softer inflation figures would herald a Fed pivot, says Ian Shepherdson of Pantheon Macroeconomics. “A single month’s improvement falls far short of what [we] need to see before we are confident that inflation is moving down,” he said. Powell noted that “the historical record cautions strongly against prematurely loosening policy”. Powell is referring to the 1970s, say Thomas Sargent and William Silber in The Wall Street Journal. When inflation spiked to 11% in 1974 thenchair Arthur Burns reacted by hiking rates to more than 12%.

That move temporarily brought inflation under control, but the resulting recession and unemployment then prompted Burns to ease too quickly. He cut short-term rates in half, causing a second price spike that eventually saw inflation peak at 14.6% in 1980. The Fed remained on the back foot in the fight against the “great inflation” until the early 1980s.

Powell will be keen not to repeat that experience, says Russ Mould of AJ Bell. Low unemployment and few “signs of distress in the wider US economy and financial system” from hikes so far will probably embolden the Fed to “keep monetary policy tighter for longer than financial markets currently expect”.

The Federal Reserve, America’s central bank, raised interest rates in the US by three-quarters of a percentage point yesterday. That’s the second month in a row. The federal funds target rate is now 2.25% to 2.5% (it’s a range, rather than one number as with the Bank of England).

Once upon a time, not so very long ago, the idea that the Fed would be pumping what the market once viewed as six months’ worth of rate rises into just two months would have had people expecting the end of the world.

And certainly markets haven’t exactly been enjoying the ride. But the Fed has persisted.

Thing is, yesterday, alongside the 0.75 percentage point rise, we also got a whisper of a hint that the Fed might decide to ease up a little, depending on what happens next.

To be more specific, Fed boss Jerome Powell said “it likely will become appropriate to slow the pace of increases”.

That hint was sufficient to send the S&P 500 up 2.6% and the Nasdaq up by 4.1%.

The thing is, though, Powell also warned that “another unusually large rate rise” could be appropriate too, depending on the data.

So is the market falling for wishful thinking? I can’t help but think that it might be. Here’s why.

The Fed now feels financially omnipotent

I was listening to Bloomberg’s Odd Lots podcast yesterday. The guest, former senior Federal Reserve trader Joseph Wang, made a point which really made me rethink my view on central banks.

Here’s a bit of context.

For decades now, the core assumption about central banks is that they will intervene in markets if they fall fast enough or far enough. This tendency was best known as the “Greenspan put”, after Alan Greenspan, the Federal Reserve chair who first put it into practice. It was never official policy, but Greenspan’s habit of cutting interest rates at any sign of trouble certainly bred an element of complacency.

This belief that the Fed has a pain point at which it will act to “save” the market is still apparent. Investors keep thinking that a turning point is coming any time now, which explains why they all alighted on Powell’s words.

But why did the “Greenspan put” exist in the first place? It was because Greenspan was worried about systemic threats. For example, hedge fund LTCM was bailed out in 1998 because of Greenspan’s fears that a collapse of the highly-leveraged fund would create a chain reaction and bankrupt most of Wall Street.

In 2008 we had the financial crisis, and the Fed learned the hard way that some institutions were too big to fail. As a result, in the decade following, the Fed made sure it only took baby steps and tried never to do anything to take the fragile market by surprise.

But all through this process, the central bank was creating more and more systems by which it could intervene more and more aggressively and in more and more markets. By the time the 2020 pandemic panic came round, the Fed was able to declare that it would literally buy junk bonds, effectively scrapping bankruptcy (should it wish). Using swap lines, it also did a great deal to prevent overseas markets from blowing up.

So in effect – and this is Wang’s point – the Fed now feels powerful enough (and you can see why) to be relatively confident that no crisis can be big enough to be systemic anymore.

The “Greenspan put” created massive moral hazard. The fact that the market could rely on being bailed out every time it took too many risks and took things too far, meant that it just kept on taking risks and pushing things too far.

The irony now is that, having underwritten everything, the Fed may have created a different kind of moral hazard. It now feels that it can stop any crisis in its tracks. And as a result, it can raise rates as much as it likes (or at least as much as it takes to tackle inflation) without breaking anything.

In turn, that implies that the Greenspan put is not only dead and buried – it implies that the Fed no longer really cares about the market reaction except in as much as it either tightens or loosens financial conditions.

Something always breaks

That’s a very different world for investors to be operating in – an actively market-hostile (or at least market-agnostic) Fed rather than one which is pandering to every panic and tantrum.

Perhaps more importantly – something always breaks. Not sure what it would be this time around, but something in currency markets (if the dollar keeps surprising everyone) or sovereign debt markets (as Jonathan Compton wrote in a recent issue of MoneyWeek, we’re overdue a wave of defaults) seem likely candidates.

We’ll see. In any case, for now, markets might keep bouncing given the grimness of sentiment out there. But I’d be surprised if the Fed is pleased about the reaction to yesterday’s press conference. The reality is that until inflation shows genuine signs of coming under control, the bias towards tightening won’t relax – and if markets don’t get the message, the Fed might have to act even more aggressively.

I was at a dinner the other night with a buddy who is a much cleverer investor than I am. The conversation went something like this.

Clever Mate: “Inflation is 10%. Rates are going to have to go to 10% to get it under control. I’m 60% in cash.”

Me: “The system can’t take rates at 10%.”

Clever Mate shrugs.

There is an awkward silence.

Clever Mate: “It will have to learn to.”

Another more awkward silence follows as I digest the implications.

Do central bankers have what it takes to tackle inflation?

Have today’s central bankers – the likes of Jerome Powell, Christine Lagarde and Andrew Bailey – got the bottle to “do a Volcker” and put interest rates up to these kinds of levels? (In 1981, then-Federal Reserve chairman Paul Volcker raised the Fed Funds rate to 20%.)

It’s not just the chair or the governor, of course – though they will be the ones making the announcement – but the boards behind them. To make such a decision, with such ramifications, would not just require extraordinary bottle, but extraordinary conviction as well. It’s hard to have one without the other.

I’m not sure Bailey or Lagarde have the right belief systems. In the case of Lagarde, I’m as sure as dammit the career and reputational risk would be intolerable to her.

So my view, on this side of the Atlantic at least, is that a softly, softly approach will prevail and that interest rates will go up slightly, while those in charge prevaricate and hope that this unfortunate inflationary episode does prove to be temporary and passes.

We will have a clearer idea of Powell’s intentions later this week when he makes his announcement.

But here’s the point: Volcker is widely credited with curtailing the inflation of the 1970s. However, when he was appointed in 1979, inflation was long entrenched. From the Vietnam War to the abandonment of the gold standard in 1971 to the oil crisis of 1973 and through all the economic turmoil of the 1970s, inflation was not something new or just a few months old, as this episode is today.

Volcker’s hiking of interest rates came off the back of all this and, what’s more, US president Jimmy Carter appointed him specifically to do what he did.

Even against all of that, his actions still provoked enormous ire.

Today’s central bankers do not have the same platform. The inflation narrative is too new, and there is still the hope that this is all temporary. So my forecast is for them to do the least possible for now, with Powell probably remaining the boldest of the three.

Interest rates may have to go to 10%, as my buddy argues, but the stage is not yet set – and this current pullback in commodities may give them some respite.

Inflation redefined

I had a thought in the shower this morning, as you do.

The classic definition of inflation, as regular readers will long since know, is “the expansion of the supply of money and credit with the consequence of higher prices”. You inflate – blow up – the money supply and as a result prices go up.

However, because of semantic shifts (which is a high-falutin way of saying “a shift in the meaning of language over time”) this is no longer the definition of inflation. Inflation now means “higher prices”.

Somewhere along the line, the bit about expanding the supply of money and credit got dropped.

The semantic shift has gone a stage further still. Inflation no longer means just rising prices, but rising prices of goods and services included in the consumer price index (CPI) measure of inflation.

So house prices rising, for example, doesn’t mean inflation.

It’s nuts because, as we know, the main reason house prices go up is because of an increase in the supply of money and credit – more and cheaper mortgages.

However, such semantic shifts are beyond the power of this lowly writer to control. So there is little more I can do than rage, rage against the dying of the light, then go about my day.

Anyway, I’ve got through the preamble, so here’s the thought: inflation, by its modern definition, actually leads to a shrinking of the money supply, or at least it should do, if central banks follow their remits to curb it.

If inflation is 10% then interest rates go up to curb it, though perhaps not as high as 10%. As interest rates rise, there is a scramble to deleverage and pay down debt (leverage is another means by which money and credit are created).

In other words, with inflation (by today’s definition) the supply of money and credit contracts. That means asset prices – house, bond and equity prices – fall, as they are what we use leverage to buy. Even car prices (finance costs more).

These are mostly not included in CPI, but in such a deflationary event as interest rates rising to levels concomitant with current CPI inflation, you can expect CPI to fall too.

To summarise, inflation originally meant the expansion of the money and credit supply with the consequence of higher prices. Today, inflation and the central bank reaction to it portends the contraction of the supply of money and credit with the consequence of lower prices.

That is some semantic shift.

I don’t know how central bankers get us out of this. But no doubt all sorts of plans with even longer and more unpronounceable names than quantitative easing (QE) are being formulated as we speak.

Remember how they suddenly came up with QE in 2008? We all looked on, baffled and blindsided. Expect similar rabbits to be pulled out of hats.

Dominic will be performing his show, How Heavy?, a lecture with funny bits about the history of weights and measures, at the Edinburgh Fringe this August. You can get tickets here.

Not being a Fed-watcher, I have been rather slow to this particular narrative I’m afraid, and it only really dawned on me last week as I was losing money trying to catch falling knives in the stockmarket.

It was Zoltan Pozsar writing for Credit Suisse who switched on the lightbulb for me. He’s the new rockstar among institutional market strategists.

A couple of other analysts have reached the same conclusion. It’s this: the Federal Reserve and America’s other policy-making powers that be, actually want the stockmarket lower.

The Federal Reserve really does want to fight inflation

I’ve heard so much hot air coming out of government officials’ mouths over the years that I think my mind is actually programmed now not to believe a word they say.

It’s not that I’m treating what they say with a healthy dose of cynicism; I’ve reached unhealthy levels of cynicism. My default, so low is my trust, is now not only not to believe a word they say, it is to assume they are lying. Probably not a good place.

It turns out that sometimes those in power do actually tell the truth. I got my first surprise dose of this earlier this year from Liz Truss, the foreign secretary, when she warned that the Russian troops on the other side of the Ukrainian border were about to invade.

Pull the other one, I thought – Russia wouldn’t do that. It turned out that Truss was talking straight, and her intelligence was correct.

When US president Joe Biden said his top economic priority was getting inflation down, my inner cynic muttered: “yeah, course it is mate.” It turns out what he was saying might actually, believe it or not, be true.

The Federal Reserve’s primary mandate is to keep inflation down. It might be that its chief, Jerome Powell, is taking this mandate at face value. All that stuff about his hero being Paul Volcker might even be true too.

Lower asset prices help the cause.

Back in 2008, and for many years since, everyone in Policymakerland was worried about deflation, and every effort went into staving it off. So we got QE (quantitative easing), ZIRP (zero interest rate policy) and all the rest of it. We got very used to it. It went on for so long, it became normalised. The idea that they would ever do anything else seemed far-fetched.

But, no, in Policymakerland they are genuinely worried about inflation, and so asset prices are not going to be defended. Au contraire. They want them to fall.

Bear markets mean financial conditions tighten. Tighter financial conditions mean lower money velocity and lower inflation, according to modern definitions at least.

The Fed is talking tough, and it might be that talking tough does a lot of the job for them – and they might not have to actually act as tough as they talk.

If they can get stock prices down a bit, house prices down a bit, and a lot more caution around the place, with just a bit of jawboning, then the need for higher interest rates will diminish, and the Western world might not actually implode.

Falling cryptocurrency markets help the cause too. There won’t be that particular thorn in the Fed’s side exposing the shortcomings of fiat money.

Tighter conditions will put some upward pressure on unemployment, which means the upward pressure on wages will go away too, and that will help reduce inflation.

If this has to happen some time, that time is now, in the second year of an election cycle. Come 2023, the priority will shift to getting the economic conditions in place to win the next election. Part of this of course is lower inflation, but they will want the correction in the past and asset prices moving back up again.

OK. So if you buy this theory – how far do stocks fall?

How low can the S&P 500 go?

Currently we are at 3,880 on the S&P 500, having been as high as 4,800, so we are off about 20%. Another 10% or 15% would take us to the low 3,000s.

Best-case scenario, I’m going to say 3,600 – that’s the post Corona-panic high. Worst case? Down around 3,000 at the 2019 highs. Most likely, I’m going to guess somewhere in the middle at 3,400 – the 2020 pre-lockdown highs.

But the bottom line is this: the “print money and protect asset prices at all costs” narrative has gone; it’s history.

The issue is no longer deflation, by their definition. Now it’s about inflation. They’ve been able to ignore it for years by crooked measures, ignoring asset prices and all the rest of it. They can’t any longer. That’s what they are now fighting.

As they say, “don’t fight the Fed”.

It won’t be the case forever – elections have to be won – but it seems the case for now.

Psychologically, we might need some despair and maximum pessimism before the bear market can be deemed over. There still seems to be too much optimism about. We need to be at that point of perception that the bear market is entrenched and we are never going to get out of it before it can end; we haven’t reached that point yet.

Everything bubbles on the way up, everything pops on the way down.

It might be, by the way, that UK stocks – small and large – turn out to be a very good place to hide (I’m not saying the UK economy – stockmarkets and economies are different beasts).

My reasoning? A presentation by fund manager Gervais Williams that I saw at the UK Investor Show last weekend. UK stocks have been rubbish for 20 years, but in the inflation of the 1970s they were one of the best global places to park capital. Fingers crossed the same thing happens this time around.

Dominic’s film, Adam Smith: Father of the Fringe, about the unlikely influence of the father of economics on the greatest arts festival in the world is now available to watch on YouTube.

SEE ALSO:

We’re in a bear market – change the way you invest

Everything is collapsing at once – here’s what to do about it

The position of central bankers today “recalls an old joke about a cab driver telling a lost tourist asking for directions: If I were you, I would not be starting from here”, says John Plender in the Financial Times. The Bank of England has warned that inflation will top 10% later this year while issuing gloomy growth forecasts. As central banks “try to engineer a soft landing” the risk of a “policy error” that crashes the economy is high.

“The Bank of England is skirting around the ‘r’ word but its grim set of growth forecasts all but confirm that the UK is heading for a recession next year,” says Mehreen Khan in The Times. Policymakers last week raised interest rates by 0.25 percentage points to 1%, the highest level since February 2009. Three of the nine members of the monetary policy committee wanted to go further and voted for a 0.5% rise. Markets now expect UK interest rates to keep rising until they hit 2.5% next year.

Racing out of control

“For more than a year now, Threadneedle Street has kept its head in the sand”, even as it became clear that inflationary pressures in commodity and labour markets were racing out of control, says Liam Halligan in The Daily Telegraph. Policymakers argue that the war in Ukraine has changed the outlook, but that is nonsense. In January – pre-invasion – “CPI inflation was already at 5.5%, a 30-year high”. Caught behind the curve, the bank will now have to raise rates faster, inflicting unnecessary economic pain on households in order to “slay the dragon” of price rises and win back some of its battered credibility.

In America, the Federal Reserve has gone further. Last week it raised interest rates by half a percentage point and also started the process of unwinding “its huge bond holdings”, says the New York Times’ DealBook. The move “signals urgency” about getting inflation back under control. Fed chair Jerome Powell said that further half-point increases are “on the table”. Until recently the Fed had “believed that inflation would ease as supply shortages moderated and as the economy evened out after early-pandemic disruptions”. Now renewed lockdowns in China and the war in Ukraine mean that “the notion of a return to some kind of pre-pandemic normal without intervention has been abandoned”.

Stockmarkets are getting the message that the Fed is serious about tighter policy. The S&P 500 has suffered five consecutive weeks of losses, its longest losing streak since 2011, and is down more than 16% since its peak. That’s the worst four-month start to a year since 1939 and a technical bear market (defined as a 20% drawdown) seems imminent. On Monday, global shares, as measured by the FTSE All-World index, had their worst day since June 2020.

“Unfortunately for investors, the Federal Reserve probably doesn’t feel their pain,” says Justin Lahart in The Wall Street Journal. In the past the Fed has taken pains not to sink the stockmarket, but today inflation-fighting has become its priority. With valuations still high and US labour markets robust, they have little reason to pause the rises. There is likely plenty “more pain in store for stocks”.

A central banker gave investors a nasty wake-up call this week. It wasn’t one of the usual suspects – Federal Reserve chairman Jerome Powell, or Bank of England boss Andrew Bailey. It was Lael Brainard, who is set to take over as vice-chair of the Fed.

On Tuesday, she warned that quantitative tightening (QT – the process by which the Fed sells the bonds it bought under quantitative easing) will start earlier and be more aggressive than investors had hoped.

Why is this significant? Because when Brainard was nominated to take the vice-chair role by US president Joe Biden late last year, she was widely viewed as a “dove” who would err on the side of loose monetary policy, and had occasionally nodded towards the ideas of modern monetary theory (MMT – funding public spending via unlimited money printing). So much for that.

Markets are starting to wake up

Before you start imagining that we’re heading for a repeat of the early 1980s, with the Fed pushing interest rates well into double-digit levels to crush inflationary pressure, it’s worth noting that central bank resolve has yet to be tested by the market.

The particularly grim tone of news headlines right now, along with attention-grabbing volatility in oil markets, has obscured this fact, but the reality is that most global stockmarkets simply haven’t done that badly this year.

For example, from its most recent high at the start of 2022, to its most recent low in mid-March, the S&P 500 fell by around 13%. That’s a “correction” (down more than 10%), but not a “bear” market (down more than 20%). And since then, it’s rebounded by about 7%, meaning it’s only down around 7% for the year to date.

That might be painful for investors who have been conditioned to “buy the dip”, but it’s hardly a big fall. In the context of a major war in Europe, high and rising consumer price inflation, and even rising interest rates, some might argue that it is positively miraculous.

Of course, this sudden urgency to tackle inflation does rather imply that central banks are already too late. One sign that markets are now taking inflation seriously is that while bond prices have slid (and yields have risen, as a result) gold has performed well.

In recent years, higher bond yields have meant falling gold prices (gold pays no interest, so if bond yields rise, they should become more appealing in relative terms). Yet they have now “decoupled”. As Louis-Vincent Gave of Gavekal points out, “the fixed-income market and the gold market are sending the same message: deflation is no longer the main threat for portfolios”.

Novelty is out of fashion

So investors have to contend not just with rising inflation, but also with a less predictable Fed. That’s not an easy environment to invest in. So stick to tried and tested principles: buy cheap and buy stuff you understand. Novelty is out, and old-fashioned investing is back.

For example, on page 28 John Chambers looks at how technology hasn’t proved to be a magic bullet for the insurance sector as some had hoped, and recommends some rather more traditional Lloyd’s of London insurers instead.

Meanwhile, speaking of gold, on page 18 Dominic looks at why gold-mining stocks have done so poorly relative to gold. More importantly, he wonders if that might change soon, and how you might profit.

“The expectation going into this year was that we would see inflation peaking in the first quarter and maybe levelling out” before cooling in the second half of the year, US Federal Reserve chair Jerome Powell said this week. “That story has already fallen apart.” With annual inflation running at 7.9% in the US and 6.2% in the UK and global commodity prices surging because of Russia’s invasion of Ukraine, central banks around the world are being forced into inflation-fighting mode.

Last week the Fed raised interest rates for the first time in four years, while the Bank of England delivered a further 0.25 percentage point hike to 0.75%. This week Powell suggested that the Fed could even serve up a half-point increase (rather than the usual quarter-point increment) at a future meeting if it felt inflation was running out of control.

Don’t mention the war

The key message from central bankers in Europe and America is that the war in Ukraine will not derail their plans to tighten monetary policy, says Neil Shearing of Capital Economics. The risk is that this cycle of interest-rate rises will end up causing a recession. The “lessons from history are troubling”. Of the 16 tightening cycles done by the Fed, Bank of England and European Central Bank since the late-1970s, 13 ultimately ended in recession.

The Bank of England now projects that UK inflation could hit 8% in the coming months, four times the 2% target, says Mehreen Khan in The Times. Even “double-digit inflation” looks a possibility later this year, for the first time since the early 1980s. But critics think the Bank is “dangerously behind the curve on taming inflation”, with the Bank’s reference to “further modest tightening” taken as an indication that it intends to hike less quickly than the Fed from now on. “The Ukraine crisis has changed the mood.” Markets are now expecting UK rates to be around 2% come the end of the year, down from a forecast of 2.5% previously.

Stocks are on thin ice

Tighter monetary policy has caused bonds to sell off as markets demand higher yields. US two-year Treasury notes are on course for their worst quarterly performance since 1984. Yet surprisingly stocks have so far avoided the pain, with US markets enjoying their best week since November 2020 last week and continuing to rally this week. In Europe, the Stoxx 600 index has erased its post-invasion losses. In another sign that markets have digested the invasion shock, the Vix index of expected volatility derived from S&P 500 option prices – dubbed Wall Street’s “fear gauge” – has fallen back to early February levels.

Higher interest rates should be “terrible for stocks and even worse for unprofitable tech shares”, says James Mackintosh in The Wall Street Journal. So why is even Cathie Wood’s ARK Innovation ETF of highly speculative stocks enjoying a bounce? Some traders are going bargain-hunting: over the last 30 years, they have got used to buying dips on the expectation that the Fed will “ride to the rescue” if stocks tank. But with central banks now focused on fighting the inflationary peril, buyers shouldn’t count on a “Fed backstop” this time.

The most important thing to remember about markets is that they’re all about expectations.

When something is already expected, it will already be “priced in”. It doesn’t matter if it’s “good” news or “bad” news. If markets already knew it was coming, they won’t react when it actually comes.

I’m just starting with this point this morning because it helps to explain some of yesterday’s otherwise quite confusing market moves.

The Federal Reserve was as aggressive as expected

Yesterday, the Federal Reserve, America’s central bank, raised interest rates for the first time since 2018. The monetary policy squad voted eight to one to raise by 0.25 percentage points to a target range of 0.25% to 0.5%. The single dissenter wanted to raise by half a percentage point. So no doves here.

The Fed (as manifested by chairman Jerome Powell) also promised to raise rates quite a bit more. It said that the US economy can take it, and made it clear that the whole “transitory” business is now behind it, and it wishes with hindsight that it had raised rates already.

Bear in mind that this is all being stated at a time when America’s headline stockmarket index is paddling in the shallows of correction territory (down more than 10% from its most recent high) and the Nasdaq has already taken a bracing dip into bear market territory (down more than 20%).

This is not the cuddly Fed that investors may have grown used to in recent decades. The obvious question is: why didn’t markets freak out? And the obvious answer – as alluded to in our introduction today – is because markets already expected it.

Inflation in the US is sitting at a headline rate of nearly 8%. The US interest rate (until yesterday) was sitting at 0%. Not even Alan Greenspan (well, OK, maybe) could’ve sat on his hands with that kind of disparity.

The question was never: “will the Fed be aggressive?”, it was: “how aggressive will the Fed be?” And given that markets had been pricing in up to seven interest-rate rises this year, it was going to be hard for the Fed to go any harder than markets expected.

So the most important interest-rate-setting meeting since the pandemic turned out to be priced in.

Russia’s invasion of Ukraine is pricing in more of the same

The question then becomes – why did markets enjoy a solid rebound yesterday, once the Fed was out of the way?

There are two main candidates. One is the invasion of Ukraine. We keep getting hints that we might be edging closer to some sort of peace deal. Over the last few days I suspect that this is what has put a dampener on the chaotic rise in commodity markets (though there’s a lot going on in the plumbing there too which might be a big contributor).

Obviously, the war is a tricky thing to “price in”. But right now I think we can take a good guess at where markets are with it, and that’s all you really need at this sort of level.

Basically, as long as this stays within the borders of Ukraine and doesn’t spill over to become World War III, markets will park it as an issue. Russia has become more of a pariah, but it’s been on that path since at least 2008, and took many more steps down it with its 2014 invasion of Crimea.

Markets are cold-blooded things, and they may well be wrong. After all, if anything could be described as irrational in the narrow sense, it’s war, and markets aren’t great with irrationality. But you can see that this – a messy settlement with ongoing Russian tensions – is what’s being priced in.

The big surprise came from China

So that leaves us with the one genuine surprise from yesterday. And that came from China.

Something quite interesting has been happening in Chinese markets. In some ways, what’s been happening may well have been the most significant impact of the sanctions on Russia.

What am I talking about? The shutting down of Russian markets made investors do one significant thing - they re-evaluated the importance of property rights. And one major investment destination where property rights have been increasingly called into question in the past year, is China.

There’s been an economic slowdown, a property crash of sorts, and ongoing Covid-19 shutdowns to contend with too. But the thing really worrying international investors over the past year or so has been China’s increasing hostility to shareholder capitalism. It no longer seemed compatible with Xi Jinping’s “common prosperity” approach.

So you can see why investors might want to reconsider whether having money in China was really such a sensible option, particularly when it was entirely unclear which way the country was jumping on Ukraine.

It appears that Xi has decided that there are still gains to be had from milking the international capitalist system, and that the fear has gone far enough. He might also have woken up to the fact that a chaotic slide in markets isn’t any healthier for social cohesion than wealth disparity is.

As Sofia Horta e Costa reports on Bloomberg, “China’s top financial policy body vowed to ensure stability in capital markets, support overseas stock listings, resolve risks around property developers and complete the crackdown on Big Tech ‘as soon as possible’.”

In other words, “we get it, markets matter to us too, we’re going to make sure everything gets sorted”. You could call it the “China put”, which markets have welcomed now that the “Greenspan put” (the implied promise that the Fed would always step in to prop up equity markets) has been retired.

As a result, Hong Kong markets and Chinese stocks listed overseas rocketed (bear in mind of course that the Hang Seng China index had previously dived by 24% in a single month).

Is this a long-term change of heart? I very much doubt it. As Andrew Batson of Gavekal notes, “the odds are... that this is a change in short-term tactics, not long-term strategy.”

But it does explain the bounce. And while you might not fancy filling your portfolio full of Chinese stocks, a more relaxed approach to monetary policy from the biggest economy in Asia probably bodes well for stocks in that part of the world in particular.

With inflation at its highest level in 30 years, the global economy struggling to recover from the pandemic, and now with a conflict in Ukraine threatening to send commodity prices spiralling upwards, you might think that the Federal Reserve, still the most important player in global finance, had enough on its plate already.

Yet US president Joe Biden is busily appointing a series of woke warriors to its board to see that it is also tackling climate change, promoting inclusion, diversity and gender awareness, and sorting out reparations for slavery. By politicising the Fed, Biden risks destroying its credibility – and that matters for the whole of the global economy.

The Fed goes woke

The Fed, like other independent central banks, was always meant to be beyond politics. Its role was to maintain the stability of the banking and financial system, and keep employment high and the economy expanding, so long as those objectives didn’t undermine the key priority of price stability. It was a narrow, technocratic remit. Indeed, staying out of politics is part of the reason for its success. It is precisely because individuals, companies and investors believe in the Fed’s neutrality that they have confidence in it.

Biden and his advisers are now intent on undermining that. True, he reappointed Jay Powell, a Republican, as chairman to lead the bank. But the rest of his appointments are proving more controversial.

Sarah Bloom Raskin, for example, has been nominated to the key post of Fed banking regulator, making her one of the most powerful figures in global finance. And yet Raskin is best known for her radical views on central banking and climate change, arguing that financial institutions should distance themselves from any form of financing of fossil fuel and that, if they don’t move quickly enough, the Fed should punish them. “Raskin’s views would have devastating consequences” for the energy industry, a Republican senator said at her confirmation hearings.

Biden has also nominated Lisa Cook to the board of the Fed, an economist who has campaigned for slavery reparations, among other trendy causes.

One needn’t disagree with the politics to see the problems. First, the issues are a distraction from the main task. Running a central bank is never an easy task, even at the best of times. The history books are littered with policy blunders that often had catastrophic consequences, from the Great Recession of the 1930s, to the inflation of the 1970s, to the financial crash of 2007 and its aftermath.

Plotting the right path between monetary policy that is too tight and too loose is far from easy. Nor is keeping on top of a complex financial system, with liabilities that may crop up anywhere, a simple task, no matter how many experts are on the team. These are especially trying times right now. The Fed should focus its mind and leave dealing with climate change to others.

Why neutrality matters

Second, the politics may well undermine the Fed’s credibility. A central bank often has to make unpopular decisions. It might have to raise interest rates sharply even if stockmarkets are tumbling, or unemployment is rising, or homes are being repossessed and companies are going bankrupt. It can probably manage that so long as everyone accepts that it is a neutral institution doing its best to manage the economy. If people start to see it as the agent of a particular brand of politics, then that is not going to work any more. The legitimacy of the Fed will start to ebb away, and once that starts to happen it is in big trouble.

A central bank is meant to be a neutral custodian of the financial system and the economy, keeping inflation under control and supervising the banks. None is more important than the Federal Reserve. It is the custodian of what remains the world’s reserve currency and the anchor of a financial system that takes in most of the world. This is no time to undermine its credibility – and weaken the dollar as the lynchpin of global financial markets.

Ever since the late 1980s or so, the Federal Reserve, America’s central bank, has earned itself a justified reputation for being a pushover when it comes to markets.

This manifested itself in the phrase the “Greenspan put”. This was the idea that Alan Greenspan, Fed governor between 1987 and 2006, would always act to cushion markets if they looked wobbly.

The “put” survived Greenspan. His successors, Ben Bernanke and Janet Yellen, always managed to be more “dovish” than markets had expected.

Last night, current Fed chair Jerome Powell bucked the trend. And investors didn’t like it one bit.

Why the Federal Reserve has changed course

The Federal Reserve had its first interest-rate setting meeting of the year this week. Last night (UK time) they told us what they’d decided.

The actual decision wasn’t a surprise to markets, but the tone – showing no signs of concern about the recent market sell-off, for starters – was a lot more hawkish than investors had expected.

As a result, markets now expect interest rates to rise further and faster than they did before.

So what did the Fed say? Come March, the Fed will stop printing money to buy assets (ie quantitative easing – QE – ends). Not only that, but it’ll probably raise interest rates – maybe even by half a percentage point, not just a quarter point. Not only that, but it’ll quite likely start quantitative tightening (QT) at some point soon after that.

QT involves the Fed reversing QE. In other words, it doesn’t just stop printing money to buy assets, it starts to sell off the assets that it has already bought.

The real shift was in Jerome Powell’s tone. Markets quite often expect to get a bit of coddling from the central bank boss, particularly if rates are going up.

Not a bit of it this time. Powell emphasised that he’s worried about inflation. He emphasised that he sees inflation as a risk to workers and the labour market (usually, the labour market has been seen as a reason to keep rates low).

Most importantly, as John Authers points out on Bloomberg, “the central bank has also shown that it can live with the amount of equity market turbulence that it’s created so far”. There may well be a “Powell put”, but if there is one, it kicks in at a much lower price than investors have grown used to in the Greenspan/Bernanke/Yellen years.

What’s behind the change of strategy? As we’ve noted before, this is all driven by inflation. Powell’s predecessors had it easy. When you’re more worried about deflation than inflation, you can just print more money. That makes you popular.

Inflation is much harder to tackle. It’s now a headline issue, which means it’s a political issue (both here and in the US), which means that suddenly it’s public enemy number one, which means that Wall Street needs to fend for itself.

From that point of view, it’s better for Powell to talk tough now and get the market to tighten financial conditions for him (a stronger dollar and a weaker stockmarket are both forms of tightening), rather than leave it until he needs to do something much more drastic.

In effect, he’s hoping that a stitch today will save nine later. Because if inflation doesn’t go away, the level that interest rates might have to rise to would be very damaging indeed. So I wouldn’t expect Powell to shift course until there are either signs of serious financial distress (in credit markets say) or signs that inflation is alleviating (though I think he’d want to see more than just one or two readings before he changed tone).

What does this mean for your money? Buy banks, for one

We’ll keep an eye on all that. But meanwhile, what does this hawkishness all mean for your portfolio?

It’s easy to get caught up in the idea that a sliding US stockmarket will drive everything down with it. That’s a reasonable assumption, because it very often does.

However, the good news (for UK investors in particular) is that there are some industries that like rising interest rates. Bank stocks finally seem to be waking up from a lengthy slumber.

For example, Lloyds (which I own) is up around 5% so far this year. For perspective, the FTSE 100 – which of course also benefits from big oil, as well as the banks – is just about flat, and the Nasdaq composite is down nearly 15%. And Lloyds is far from being the only one.

It’s striking that the tech bubble and bust of the late 1990s saw the big tech companies falling out of favour and being neglected by investors for a good decade or more. After the fallout from that bubble, during the 2000s, the places to be were commodities and – in some cases – the financial sector.

Since the global financial crisis, banks outside the US have been largely neglected or treated as pariahs, certainly the boring old UK ones, which were detested by consumers (in many cases, rightly) and also subject to one of the biggest backdoor “QE for the people” schemes in history, the PPI scandal.

It’ll be fitting if the bursting of the current tech bubble (because arguably that’s what it is) coincides with a new bull market in neglected financials and other “dinosaur” stocks.

In fact, Julian Brigden of Macro Intelligence 2 Partners puts it very well in the latest MoneyWeek podcast, when he tells Merryn: “the first shall be last and the last shall be first”. You should definitely listen to this one if you haven’t yet – just click here.

It’s been one of those weeks – they happen unfortunately. There seems to be a perfect storm of negative news stories, and markets have got the jitters.

First, there’s the mounting conflict on the Russia-Ukraine border, the implications of which are tremendous. Never mind the potential imminent war, it has also revealed just how vulnerable the divided West now is.

Then there’s the triple threat emanating from the US Federal Reserve, America’s central bank, as it faces the challenge of inflation, which is now very real and present, even if you use the central bank definitions (asset price inflation has been rampant for decades, now it has spread into consumer prices).

So why do I say triple threat from the Fed? There is the likelihood that interest rates go up; there’s the tapering (with the Fed reducing the amount of money it prints to buy bonds); and there’s so-called “quantitative tightening” (QT) – whereby the Fed actually sells off some of the $9trn in assets it currently holds.

Whether the Fed will follow through with this triple threat remains to be seen. We’ll have more of an idea this evening (UK time) when Fed chair Jerome Powell makes his next utterance and tells us all what has been decided at its latest meeting. Tighter policy will be needed to control inflation, he has said – but how tight can the Fed go? “Not very”, is the answer; Wall Street is addicted to stimulus.

Goldman Sachs argued yesterday that the Fed will need to raise interest rates four times this year. Respected market historian Russell Napier estimates that 1.5% is the most markets can take. Currently, we stand at zero.

Add to this perfect storm the unwinding of one of the most incredible bull markets we have ever seen in history – the tech bubble or bull market of the last ten years, your choice of words will depend on whether you were invested or not – and you can see why it has been such a gruesome week.

The big names in the Nasdaq stock index propped it up in the latter part of last year, while the non mega-caps were in decline. But in 2022, even once-seemingly impervious big names such as Facebook, Amazon, Apple, Microsoft and Alphabet have taken a battering.

And, of course in the land of bitcoin another cryptocurrency winter is upon us.

The price of “real” stuff is holding up nicely

Times like this, however, can be very instructive. What holds up best will be the place to be when the inevitable rebound comes. I have bad news for Powell – what has held up best are metals and energy.

Usually when you get these periodic pops of the “everything bubble”, you would expect them to sell off harshly too. They have sold off a bit, but nothing like what we have seen in tech.

This bad news for Powell? Because the rising prices of metals and energy, especially, lead to a very apparent rise in the cost of living and are likely to make their presence felt in the forthcoming consumer price inflation data, putting more pressure on Powell to tighten.

Both Brent and West Texas International crude oil remain around $85 a barrel – seven-year highs. The same goes for heating oil and gasoline. Natural gas always seems to do its own thing, but it is making a low after its October-December sell-off.

Turning to the metals, in the base category, the uptrends in lead, iron ore, zinc and aluminium are all intact. Nickel to an extent too. Some have been more volatile than others, nickel especially, but the broader trend is upwards.

Copper is in consolidation mode after its bonanza in 2020 and the first half of 2021, but it is holding up near its multi-year highs.

Even the perennial disappointers – gold and other precious metals – have stood firm. Gold sits at $1,845 an ounce, having been rising steadily since early December. Silver has also been rising steadily since mid-December, though it has been weak these past few days (as you would expect in a broad market sell-off – it is a speculative metal). Even so, it is at $23.80 an ounce, when it was $21.50 a month ago. Platinum and palladium, the latter especially, have had a fair time of it too.

The short of it is this: it looks like metals and energy are going to have a pretty good 2022. They are the place to be.

The simplest way to play this is to own a company I have touted many times before, and continue to tout, BHP Group (LSE: BHP), which is diversified across the energy and metals sector. Or you might consider the BlackRock World Mining Trust (LSE: BRWM), the BlackRock Energy and Resources Income Trust (LSE: BERI) or iShares Oil & Gas Exploration & Production ETF (LSE: SPOG). These are all low-risk ways to play the bull markets in metals and energy.

Dominic’s film, Adam Smith: Father of the Fringe, about the unlikely influence of the father of economics on the greatest arts festival in the world is now available to watch on YouTube.

Prices in the US are rising at the fastest rate since 1982.

Wow. That’s a long time ago. Margaret Thatcher, Ronald Reagan, the Falklands War, and Duran Duran’s Rio album are just some of the things that were big news in 1982.

Incidentally, it was also one of the best times ever to invest in stocks; they were very cheap (to be clear, they are not very cheap now, certainly not in the US).

Enough nostalgia. A 7% inflation rate? Surely we saw some sort of ruckus in markets after that?

Not a bit of it.

US inflation at 7% – yet the US dollar fell

A US inflation reading of 7% year-on-year seems like a big deal. Why did the market do little more than shrug?

It’s all down to that magic word, “expectations”. Markets expected inflation to come in at 7% – it did. They also expected “core” inflation to come in at 5.4% – it didn’t, it came in at 5.5%, but that’s not much of a difference.

Hence the limited reaction – in the short term, at least – the markets were already pricing in the outcome that they got. Indeed, the US dollar fell on the news.

From that, you probably have to conclude that investors were braced for something even worse. Instead, they only got a near-40-year-high in inflation, and breathed a sigh of relief that the Federal Reserve probably won’t have to raise rates even faster.

This was helped by the fact that Fed boss Jerome Powell made some reassuring noises on Tuesday this week about how, although inflation was going to last longer, he thought that the Fed could unwind emergency policy without derailing the economic recovery.

A weaker dollar in turn is good news for most other assets. Ironically enough, when the dollar is weakening, you can view it as global monetary policy getting looser (everyone needs dollars, so the cheaper they are, the better).

If investors have already priced in a certain number of interest-rate rises for the Fed, but they haven’t priced in a “catch-up” from the likes of the Bank of England and the European Central Bank, for example, then it means those currencies look cheap relative to the dollar. Hence the recent rise in the pound, despite all the (literal) party political japes.

Also, it’s the start of the year. With the US looking expensive and the tech plays selling off, investors are now looking for new stories among stuff that has underperformed. That suggests almost anything that isn’t in the US should start to do better.

This does make a certain amount of sense. Inflation – despite some protests to the contrary – is not a US problem, it’s a global one. So while the Fed has already laid out its roadmap to ever-so-slightly-higher interest rates, it just means that other central banks are going to have to follow in its wake.

So we’ve got a weaker dollar, and that’s bullish for everything, right?

That’s all very well, but what about inflation?

The one fly in the ointment is that, for all that markets were relieved, inflation is still sitting at its highest since 1982. For perspective, as AJ Bell pointed out yesterday, the last time inflation was this high, the key US interest rate was at 14%.

Now, of course, that doesn’t mean rates are going up to 14% – there wouldn’t be an economy left. All this really shows is that the relationship between interest rates and inflation is not straightforward, and that where you are and where you’re going depend very much on where you’ve been (I feel that I’ve just created the beginnings of a Yogi Berra quote there, but let’s park that for now).

It’s also becoming increasingly clear to anyone with eyes to see that inflation is not transitory, however you want to define transitory. John Authers notes in his Bloomberg newsletter that even if you use a US inflation index that strips out everything that’s conceivably causing short-term inflation (food, energy, housing, and used vehicles), then inflation is still at 30-year high.

“Sticky” prices are rising too. This is not something that will simply go away just because supply chains get unsnarled.

So what should you do?

The good news is that lots of non-US assets are indeed cheap. Better yet, one of them is right on your doorstep here in Britain (apologies to non-UK readers). As Chris Brightman of US asset manager Research Affiliates points out, UK value stocks are among the cheapest assets out there right now.

That’s no surprise, given that 2021, as the FT reports, saw “investors continue to shun UK equity funds”, with UK investors taking £4.4bn out of UK stockmarket funds in the year to November 2021.

We’d suggest you go in the opposite direction. More on this – and what else to buy to inflation-proof your portfolio – in future issues of MoneyWeek magazine. Get your first six issues free here.

The last time US inflation was this high Ronald Reagan was president and Argentina was about to invade the Falkland Islands. US consumer prices rose by an annual 6.8% last month, the fastest pace since March 1982. Petrol prices surged by 58.1% in the year to November. Strip out the effect of volatile food and energy prices and “core” inflation hit 4.9% year-on-year, its highest reading since 1991.

Inflation? What inflation?

Markets were unperturbed, says Randall Forsyth in Barron’s. The pricing of US treasury inflation-protected bonds implies that inflation will come back down over the next year or two. For now, investors still have confidence in the ability of central bankers to get price rises back under control. The big worry for the US Federal Reserve is that expectations of rising prices become “entrenched”, says The Economist. The average US consumer thinks prices will rise at an annual pace of 4.2% over the next three years, according to the Federal Reserve Bank of New York. If they demand higher wages, then these expectations will become a self-fulfilling prophecy.

“In an ideal world” the Fed would be planning to raise record-low interest rates now; instead, it is still adding new liquidity to the market by buying bonds with printed money every month. The Fed should move to “taper” those purchases quickly.

The Fed risks being caught “behind the inflation curve”, says Mohamed El-Erian on Project Syndicate. For months its officials have mischaracterised this year’s surge as “transitory”. It was defensible to blame pandemic distortions when prices first took off this spring, but by the summer it was clear that supply-chain problems and labour shortages were here to stay. Policymakers instead buried their heads in the sand. The later the Fed acts on inflation, “the greater the likelihood that it will have to hit the policy brakes hard, causing market turmoil and unnecessary economic pain”.

Powell is trapped

In the 1980s the Fed only got a handle on inflation by administering “brutal shock treatment”, pushing interest rates above 20%, says Larry Elliott in The Guardian. Under the guidance of Paul Volcker, “the inflation hawks’ hawk”, the Fed presided over “business failures and mass job losses”. The “Volcker shock” accelerated the decline of manufacturing and unleashed a crippling debt crisis in Latin America. Such is the price to be paid when a central bank needs to regain lost inflation credibility. A repeat of that strategy today looks nigh-on impossible. The US economy has become so “financialised” that “Volcker redux” would cause a “monumental financial crisis”. Fed chair Jerome Powell is “trapped… Wall Street has the whip hand these days, not the Federal Reserve”.

“Central bank governors are like wild beasts,” says Ron William in the Halkin Letter. “Given too much freedom, they dominate their territory… Carefully managed in a secure enclosure… they lose the will to live and stare blankly into the far distance.” In 2018, Jerome Powell started his Fed term as a monetary hawk, but now he has been well and truly domesticated.

Have markets learnt to stop worrying and love Omicron? After a nervy fortnight, traders regained confidence early this week. On Tuesday, the FTSE 100 returned to the levels it had reached before news of the variant triggered a mini-meltdown at the end of November. Other world markets have also rallied. Brent crude oil hit $76 a barrel, although it remains short of its pre-Omicron level.

Much remains unknown about the new variant, but investors have been reassured by early reports from South Africa suggesting that while Omicron is highly transmissible, it may cause less severe illness than previous variants of Covid-19.

The Fed turns hawkish

Yet below the surface all is not well. As John Authers notes on Bloomberg, the CBOE VIX Volatility index, the US stockmarket’s “fear gauge”, spiked above 30 last week before falling back. From the global financial crisis to the advent of Covid-19, VIX spikes have almost always coincided with “a significant financial event”.

The cause this time may be as much Jerome Powell as Omicron. The boss of the US Federal Reserve said last week that he would “retire” the use of the word “transitory” to describe inflation.

The Fed’s insistence that inflation is “transitory” has been “much-maligned” as successive monthly figures show price rises sticking around, says Randall Forsyth in Barron’s. Powell has also suggested that the Fed may reduce – or “taper” – its $105bn in monthly bond purchases more quickly than planned. The Fed has bought $3trn in government bonds with printed money since March 2020, which has financed “about half” of the US government’s pandemic stimulus deficits. It is sometimes said that a central bank’s job is to remove the punch bowl from the party; in this case, the Fed “would be slowing its pour only gradually”. Faster tapering would see policy go from being “super-crazy easy to merely highly accommodative”.

In the past Powell has backed down if his hawkish comments upset markets, Matt Maley of Miller Tabak + Co. tells Bloomberg. Yet this time he has “doubled down… they’re hitting the brakes much harder”. High inflation is becoming a political issue in the US, while Powell needs a Senate confirmation vote before he can begin a second term as Fed chair next year.

No more market bailouts

Bond markets have taken Powell’s comments to heart. Yields on long-dated bonds have fallen, while those on short-term ones have risen, a sign that markets expect higher interest rates and slower growth ahead.

Traders are used to relying on the “Fed put”: when bad news comes around the Fed reliably rescues markets with easy money. The result has been that stocks sometimes rise following bad economic data (a pattern known as “bad news is good news”). The fact that Powell struck a hawkish tone even as Omicron uncertainty gripped markets has taken away that comfort blanket. For the first time in years, traders are having to get used to the idea that bad news might just be ba

It’s official: inflation is no longer “transitory”.

The world’s most powerful central banker declared yesterday that it was time to “retire that word”.

Markets promptly fell out of bed – they’re not used to the Federal Reserve talking tough.

So is this it? Are we about to see the big central bank offensive against inflation?

Transitory is out of the door

Here’s what Jerome Powell, boss of the Federal Reserve, America’s central bank, said yesterday about the dreaded word “transitory”: “We tend to use it to mean that it won’t leave a permanent mark in the form of higher inflation. I think it’s a good time to retire that word and try to explain more clearly what we mean.”

There’s a pretty obvious nuance here which I feel may have been missed amid all yesterday’s excitement.

Powell is a bit miffed. To some people, when you say something is “transitory”, you mean it won’t last long. But Powell (and other central bankers) have a subtly different take on the word.

When Powell says “transitory”, he’s not referring to a specific period of time. He just means that the inflation will wash over and through the economy, and won’t leave a mark. In other words, he simply means “transitory” in the sense of “not permanent”.

So when he says it’s time to “retire” the word “transitory”, he doesn’t mean he’s now a believer that we’re in a fully-fledged inflationary environment, he just means he doesn’t like everyone taking the mickey out of him every time he says it. Never underestimate the power of ridicule, particularly when directed at those not used to being on the receiving end of it.

Anyway. Powell didn’t just retire “transitory”. He also said that it was probably a good idea to think about “tapering” a bit more quickly. Previously, the current bout of QE - quantitative easing, or printing money to buy bonds – was meant to end in mid-2022, but it looks like they’ll wind it up earlier now.

So overall, the tone was “hawkish” – hence the drop in markets. Everything from the FTSE 100 to the Nasdaq to gold slipped off their respective perches.

No wonder; this is a bit of a slap in the face for markets. You’ve got a new and so far unknown Covid variant doing the rounds, and yet Powell isn’t taking the chance to back down from his recent change of heart on inflation.

Investors have grown used to being the number one concern for the Fed over the past decade. The likes of Ben Bernanke and Janet Yellen treated every 5% dip as though it might trigger a systemic crisis. When it came to the market, they tiptoed around like they were trying to defuse an intricately-wired bomb.

Now Powell is wading in and acting like inflation is a bigger worry than the level of the S&P 500. It’s downright insensitive.

What’s going on?

Investors beware – politics is a fickle business

It’s mostly politics. The US administration under Joe Biden is worried about inflation – and particularly about high petrol prices (to my lovely American readers, that’s what us British people call gas).

Biden faces mid-term elections next year (it’s a wonder anyone gets anything done) and it seems he’s horribly aware of what happened to Jimmy Carter. So he doesn’t want to go into those with people fretting about the cost of filling up their cars, or believing that the administration is soft on inflation.

So he’s co-ordinated a big release from America’s emergency reserves of oil. Which has serendipitously then been compounded by news of a new variant, which hammered the oil price even further.

Meanwhile, this change of political heart gives the Fed all the cover it needs to talk a tougher game on inflation.

However, there is a big gap between talking a big game and actually acting on it. First, bear in mind that inflation is sitting around 6% and the Fed is simply talking about ending emergency monetary policy a bit earlier than planned. That’s still quite far behind the curve.

Secondly, I suspect – it’s a hunch more than anything else, but I think it’ll be borne out – that inflation may well hit a temporary peak fairly soon, mostly because of base effects and because nothing goes up in a straight line.

With Powell and Biden both talking tough now, that gives fuel for Biden to say that he’s tamed inflation in the run up to the 2022 mid-term elections.

But how much more can Powell do beyond “jawboning”? Inflation might be the big political worry today, but that’s because it’s been in the headlines and because petrol prices have been going up. If you think a 20% drop in the S&P or Nasdaq won’t shift the tone pretty damn quickly, then I’d be curious to hear your reasoning, put it that way.

In short, I imagine Powell still has the market’s back. It will just need to make him prove it. And there will no doubt be “jawboning” in the other direction if it looks as though this squall in the markets is going to turn into something – forgive me – less transitory.

Until tomorrow,

John Stepek

Executive editor, MoneyWeek

US president Joe Biden has nominated Jerome Powell for a second term in charge of the Federal Reserve, ending weeks of speculation about the future direction of the world’s most important central bank. Left-wing democrats had pushed for Lael Brainard, a member of the Fed’s board of governors who has taken a tough stance on financial regulation, to succeed Powell, a Republican, in the post. Biden has instead nominated Brainard to be vice chair, keeping Powell in place for another four years. Powell will face confirmation hearings in the Senate before his new term begins in February 2022.

Biden has made the right call, says Bloomberg. The Fed needs continuity as it conducts the delicate task of unwinding crisis-era monetary policy. A new boss would have raised the risk of miscommunication and market upsets. While Brainard takes a stronger line on financial regulation, the pair don’t seem to have any major disagreements about monetary policy. The risk was rather that Brainard, a Democrat, would have been perceived as “partisan”. The last thing the Fed needs is to get sucked into febrile party-political spats.

Powell’s second term could prove a “poisoned chalice”, says Desmond Lachman for The Hill. Last year he threw the kitchen sink at financial markets to stave off disaster from the pandemic. That has helped send US inflation up to 6.2%, the highest in three decades. US stocks are at valuations “experienced only once before in the past 100 years”. That will put Powell in a bind next year: either he lets price rises rip – and goes down as the Fed chair who presided over the return of inflation – or he raises interest rates earlier than expected, bursting the asset-price bubble.

Fool me twice?

Meanwhile in the UK, Bank of England governor Andrew Bailey is “beginning to look beleaguered”, says Martin Vander Weyer in The Spectator. He appeared to suggest interest rates would rise earlier this month, only to surprise traders when they didn’t. The incident caused unnecessary market turmoil. “There’s nothing wrong with ambiguity so long as markets are convinced the central bank is ahead of the game. But in this case the governor just looked lame… and the Bank’s authority… correspondingly diminished”.

After betting wrongly on an interest rate hike in November, markets are pricing in a hike at the Bank’s next meeting on 16 December. One of the reasons the Bank held interest rates at 0.1% was because it was waiting to see what impact the end of the furlough scheme would have on employment. Strong employment data since then has allayed those concerns, while news that annual UK inflation hit 4.2% in October has raised the odds of a hike. It remains to be seen whether the Monetary Policy Committee will disappoint markets a second time.

Quick! It’s your last chance to sign up for the MoneyWeek Wealth Summit before it goes out tomorrow! Get your ticket here if you haven’t already – you won’t want to miss this.

The Turkish lira collapsed yesterday. Gold has been tripped up in its short-lived sprint for glory above $1,800 an ounce. The Nasdaq index in the US has been knocked off its most recent high in an unceremonious manner.

And US president Joe Biden just raided America’s emergency stash of oil.

What do all of these things have in common?

They’re all about inflation and interest rates.

The “safe” choice for Fed boss still rattled markets

At the start of this week, US president Joe Biden made the decision to keep Jerome Powell as the head of the Federal Reserve – America’s central bank – for the next four years. This appears to have rattled markets into believing that interest rates are going to go up faster than they’d thought.

Why’s that? It’s not entirely clear, but I have a view that I’m happy to share with you: this isn’t so much about Powell as about Biden and the overall direction of travel.

You see, some people thought that Biden was going to drop Powell (who votes Republican, apparently) for Lael Brainard, who is also on the Fed. Brainard is seen as being more “dovish” than Powell. In a narrow sense – in terms of her voting record – it’s not clear that this is true. However, she has certainly talked more about the likes of yield curve control and other “innovative” central bank policies.

So unless you want to be really pedantic, you could certainly argue that a shift to Brainard would have been evidence that a) Biden was confident of getting his own way and (arguably) b) that monetary policy would probably err on the “dovish” side.

So while Powell getting the job again makes sense in lots of ways – markets tend to be even more jittery around a new Fed boss – it also implied that monetary policy isn’t going to be as free and easy as it might have been.

I’m not sure this makes sense (I suspect Powell will err on the “dovish” side as well) but markets are all about expectations, and they were expecting someone even more inclined to print money at the drop of a hat. They didn’t get that, so they started betting that interest rates will go higher.

As a result, stuff that doesn’t like higher interest rates – gold, interest-rate sensitive growth stocks that don’t make much by way of profits – sold off, while the US dollar headed higher.

One of the most obvious casualties so far has been the Turkish lira. The lira has been in a long-term downtrend for over a decade now. But yesterday things became extreme: the currency lost more than 15% of its value against the dollar in a single day.

That’s more like the sort of move you’d expect in a cryptocurrency, and indeed the ZeroHedge blog is now referring to the lira as “erdocoin”.

Now, Turkey is almost uniquely badly governed, and has been for sufficiently long enough to allay fears of any systemic exposure. So this isn’t necessarily symptomatic of a wider emerging-market problem. But it does demonstrate what happens to the most fragile assets when rates even hint at moving.

Central banks are in a really tight spot

What does all of this mean for investors?

I think what you should take from all this is not so much that interest rates are going to rise sharply, but that the world really isn’t in much of a state to cope with sharply higher rates.

Central banks, and the Fed in particular, know this, and are caught in a very difficult position. Put bluntly, the world is carrying too much debt to be able to cope with significantly higher interest rates. But inflation is still an issue. So what can be done?

Well, on that front, the other big news yesterday was Biden’s attempt to cap oil prices by releasing 50 million barrels of oil from its Strategic Petroleum Reserve. This emergency stash of oil was put together in the 1970s in response to that particular crisis.

Why? The US is keen to drive down oil prices, because if there’s one thing consumers (ie, voters) really hate, it’s higher prices at the pump. And the threat to release reserves actually did help to put a dent in crude prices over the last week or so.

But as so often happens with these things, it was a case of “buy the rumour, sell the news” (or the other way about in this instance); Brent bounced sharply.

I’m not going to delve into the rationale for the release here because while it’s mildly interesting, it’s not especially important to today’s point. Which is this: regardless of whether this works or not (I very much doubt it will), it’s an indication of how governments are likely to respond to troublesome rising prices.

As the FT’s Lex column points out, the strategic reserve has previously only been accessed on three occasions. “Two related to wars. The third came in response to Hurricane Katrina. The only emergency Biden faces is a political one.”

This is the key. Biden (and politicians generally) cannot ignore inflation. But nor can they allow the raising of interest rates which would trigger the recession that would be required to control inflation at this stage.

So you can expect more of this sort of gesture – short-term fixes, direct and indirect price controls, capital controls – before we get to the stage where rate hikes are deemed politically acceptable.

One reason this will probably work for a little while is because you’d expect inflation to moderate at some point, possibly fairly soon, as you get the ripples from the first wave subsiding (before the next wave comes along).

At that point, you might get a declaration of victory, a sense that central banks don’t need to act as quickly as feared, and a resurgence for markets. At least until inflation comes bounding back later.

Anyway, we’ll see what happens. Suffice to say I think the market’s sudden fear of higher rates will subside given just a little bit of encouragement. That probably won’t save the lira, right enough.

“The Bank of England has blinked,” says Patrick Hosking in The Times. Despite its own forecasts that inflation will hit 5% next April, the Bank last week again opted to hold British interest rates at a “three-centuries low of 0.1%”. Quantitative easing (QE) will also continue.

Bad communication

The decision came as a shock to financial markets, which had been almost certain that a small interest-rate increase to 0.25% was coming. The pound had its worst week since August, while UK government bonds rallied as yields fell. Bank governor Andrew Bailey rejected accusations that the Bank had “bottled it”, saying that monetary policymakers are waiting for data on the impact of the end of the furlough scheme before acting. Investors should instead get used to the idea that rates are not heading up as fast as they thought, says Paul Dales of Capital Economics. While rates probably will rise to 0.25% in either December or February, it looks as though they will still only be 0.5% at the end of 2022.

Did bond “markets get ahead of themselves” by betting that inflation would force a rate hike? asks Jon Sindreu in The Wall Street Journal. No. “Markets didn’t imagine rates going up; the Bank of England told them they would.” As recently as last month Bailey said that central banks would “have to act” on rising inflation. In the coded world of central-bank speak this was taken as a clear signal of an impending rate hike that then didn’t materialise. By issuing such “unpredictable policy guidance” the Bank risks creating the kind of market turmoil it wants to avoid.

Not for the first time, the Bank has a communication problem, says Alistair Osborne in The Times. After Mark Carney’s ever-shifting “forward guidance”, now we have Bailey’s flip-flopping about when interest rates will rise. This fiasco will only give succour to those claiming that “he got the job to help to bail out the government’s finances… Every 1% rise on interest rates and inflation could cost the Treasury £25bn a year.” Andrew Bailey? More like “Andrew Bailout”.

A monetary hangover

Compare the Bank’s cack-handed communication with the slicker approach taken by US Federal Reserve chair Jerome Powell, says Ben Wright in The Daily Telegraph. Powell has avoided “scaring the horses by being extremely transparent and consistent about his intentions.” Indeed, markets greeted news that the Fed will start to rein in stimulus by sending the S&P 500 stock index to new record highs. Both central banks are arguably tightening too slowly, but at least the Fed has “laid out a clear exit strategy from the era of ultra-loose monetary policy… The same, alas, cannot be said for the Bank.”

The Fed is on track to end its QE programme by the middle of next year, although US interest-rate rises seem further away, says Katie Martin in the Financial Times. Powell has exhibited that most prized of central banking qualities: “Being boring.” But the boredom might not last. Markets are already high on monetary stimulus and it will be a long time before support is withdrawn completely. That “sets the scene for a monstrous hangover further down the line”.

Last night the Federal Reserve, America’s central bank, did what it’s been promising to do for a long time now.

It started “the taper”.

What effect would this have? How would liquidity-glutted markets react to the news that the US central bank would stop printing quite as much money to buy US government bonds (and sundry other assets)?

Why they promptly shot up of course.

A quick reminder of how markets work

The taper has begun. What’s a taper, in the financial context? If you prefer to ingest your definitions via the medium of video, just have a look here.

Otherwise, “tapering” is just a recently-invented term which describes a reduction in the amount of quantitative easing (QE - printing money to buy government debt or other assets) a central bank is doing.

It came into widespread use in May 2013. That’s when Ben Bernanke, who was the boss of the Federal Reserve at the time, started to talk about reducing the amount of QE the Fed was doing.

Note that Bernanke just talked about it. He didn’t actually start to taper for a little while after that. That’s because the markets threw a massive hissy fit in what became known as the “taper tantrum”. That bout of panic saw the Fed hold off on tapering until the very end of that year.

Fast forward to yesterday. The current Fed governor, Jerome Powell, said that the central bank will stop buying as much government and mortgage-backed debt right away. The Fed has been pumping $120bn a month into the market in all. From this month, that’ll fall to $105bn, then to $90bn in December, and by June, it’ll be done (assuming the pace is maintained).

So – the Fed is cutting the amount of money printing it’s doing. When it even mentioned the idea in 2013, markets swooned. Yesterday, both the Nasdaq and the S&P 500 hit new records, with each of them heading sharply higher after the news.

So why did stock markets pop higher this time around? In short, it’s because the Fed was less aggressive than expected.

One thing you must always remember as an investor is this: markets are constantly discounting the future. In other words, all of the market participants are constantly trying to work out what’s going to happen next, which leads to markets overall “pricing in” a version of the future.

Markets don’t always do this as efficiently as academia might suggest (if they did, we’d have the perfect prediction mechanism and, weirdly enough, markets would cease to work because there’d be no incentive to participate in them).

But they are generally pretty good at it.

If you’re struggling to wrap your head around this, just think about your own activity as an investor. Why do you buy any asset today? It’s because you think it’s going to appreciate in value in the future. You are placing a bet today which is based on your best understanding of an uncertain tomorrow.

If something is almost 100% likely to happen, then you are unlikely to be able to make money from it. For example, if a company receives a credible bid from a rival buyer, then its share price will almost instantly rise to reflect the price that the buyer promises to pay for it. The deal hasn’t completed yet – but the market “prices it in”, because it’s almost certain to happen.

This, by the way, is one reason why it’s not easy to beat the market. You have to find situations where the market is mis-pricing the future. That usually implies that you have to have an “edge” – you know something that the market doesn’t, which gives you high conviction that the market is undervaluing the odds of a certain outcome.

That’s contrarian investing. I wrote a lot more about this in my book, The Sceptical Investor (which you can get free if you subscribe to MoneyWeek today!)

The Fed is making it clear that it won’t worry about inflation for a while

But back to the topic at hand. The reason markets spiked is because they had expected the Fed to be more aggressive than it actually was.

For a start, the Fed stuck to the idea that inflation is “transitory”. This implies that interest rates won’t need to go up as rapidly or as sharply as some fear. Whether that’s the case or not (I don’t think it’s transitory) is not relevant here.

The point is that the Fed is sticking to the story that it doesn’t need to worry that much about inflation. That’s “dovish”. Moreover, Powell said that he expects this “transitory” inflation to last “until well into next year”.

That’s important. Most of us might think that “transitory” means “won’t last long”. Powell instead is using it in the sense of “this is inflation that we aren’t going to worry about”.

Powell also noted that while the Fed could adjust the pace of the tapering, “we wouldn’t want to surprise markets”. He also pointed out (again) that the Fed won’t be in a hurry to raise interest rates, even after the tapering is done.

Long story short, the Fed is still at pains to reassure investors that everything is just fine and that it’s got their backs. That state of affairs could last for some time. Hence the rise in stocks.

It’s also worth noting that earlier in the day, economic data had turned out to be extremely strong. That would have given the Fed a licence to err on the hawkish rather than the dovish side. So there was probably an element of relief that the central bank stuck to the script.

Anyway – what’ll now be interesting is how the rest of the world’s central banks act. The Bank of England is expected to raise rates (a bit) later today. One thing that could keep the bull market going is if the Fed lags the rest of the globe, which would help to keep the US dollar from rising too sharply, and thus encourage ongoing risk appetite.

But we’ll see what happens later today.

Quick reminder, before we begin this morning: on 20 October, I’m hosting a webinar with Roland Arnold, manager of the BlackRock Smaller Companies investment trust. We’ll be talking about his views on the outlook for Britain’s smaller companies against the current backdrop of supply chain disruption and economic re-opening.

Don’t miss it (particularly if you’re a fan of small cap investing) – register for the webinar now. It’s free, and it’ll also enable you to catch up later even if you can’t watch it on the day.

OK back to today.

We had a meeting of the Federal Reserve, America’s central bank, last night. It’s a sign of what a busy week it’s been that this is the first time we’ve mentioned it in Money Morning this week.

Yet this was quite an important meeting. This is when the Fed was going to give us an idea of how quickly it might try to return to “normal” monetary policy.

And the answer – surprisingly – is “quicker than you might have thought”.

The Fed talks tougher than expected

For several years – decades even – it has rarely paid to bet on the Federal Reserve being more hawkish (ie, more aggressive on tightening monetary policy) than expected. It’s usually been a good idea to bet the other way.

But yesterday, Fed chairman Jerome Powell bucked this trend. He said that it looks as though America is ready to face the “taper” (click the link to watch a video explanation of what it is, but really it just means the process of winding down quantitative easing for now).

It looks as though it’ll start from November and, by the sounds of it, if things go according to plan, it’ll be done by the middle of next year. This is faster than markets expected – and what’s worth remembering is that this is all meant to happen before the Fed thinks about raising interest rates.

So one reason for the more rapid shift on is that more Fed members – as shown by the “dot plot” (which shows when each Fed member thinks rates will be at a given point) think that the central bank will need to start raising rates earlier than it had before.

What’s also interesting is that in his press conference, Powell didn’t try to talk this back. In fact, he was very clear that – for example – it’s not going to take an absolute stunner of an employment report to make him think the time is ready to taper. He’s basically ready to do it.

So we’ve gone from a relatively dovish tone to quite a hawkish one in a short space of time. What’s changed? More to the point, why did markets basically shrug?

The answer is of course, “I don’t know”. But I can take a good guess.

One point is that the market had already reacted. I don’t agree with people who think that markets don’t care about Evergrande at all – it’s a slow burner but it’s still a biggie – but you could argue that some of the slump seen earlier this week and at the end of last was down to fear of the Fed rather than China woes.

Another is that inflation is starting to nag away at investors. They’re finally getting to the point where they’d rather see a Fed that was a) confident in the recovery and b) willing to step in to tackle inflation, rather than one that is constantly hedging and fudging and ducking the difficult questions.

Finally, we need to remember where we’re starting from. The economy (for all the concerns about Delta and about supply chains) is booming. Yet interest rates are still at 0% and will be there for another nine months. So the Fed was only hawkish in relative terms; we’re still looking at dramatically loose monetary policy.

The Norwegian central bank is already tightening up

It’s also worth looking at what’s going on elsewhere in the world. The focus on the Fed can be quite distracting. Obviously, there are good reasons for watching the US central bank more closely than any other (even our own Bank of England). The dollar is the reserve currency (put simply, the most widely-used currency), and that puts the US at the heart of the economic world.

The Fed can’t open its mouth without potentially moving markets across the globe. So yes, we very much have to keep an eye on it. However, when we’re at turning points like the current one, it’s also worth keeping an eye on what everyone else is doing. For example, this very morning the Norwegian central bank (Norges Bank) has raised interest rates from 0% to 0.25%.

As Bloomberg points out, of the ten countries with the most-traded currencies, this makes Norway the first to raise rates following the pandemic. New Zealand looked set to be the first but then someone sneezed in Auckland and the whole thing was called off.

Anyway, the move was expected. The Norwegian economy has, like most others, rallied sharply now that we’re getting past the worst of the pandemic. In fact, the economy is now doing better than it was before Covid hit.

But Norway has one big added benefit that the others don’t have – a massive sovereign wealth fund stuffed with oil wealth, which means that, unlike its peers, the national balance sheet looks pretty healthy too.

So you can’t read across from Norway directly to the rest of the world. However, the direction of travel is clear. If the rest of the world’s central banks start tightening – gently – relative to the Fed, that might even be good news for markets. It implies a weaker dollar which is almost always good news for asset prices.

As for inflation – it’s either transitory or it isn’t. I believe it isn’t. And if that’s the case, it’s going to take more than a quarter-point rate rise nine months from now to stop it.

PS, we’ll have more on all this in forthcoming issues of MoneyWeek (subscribe now and you’ll get my book thrown in too – bargain!). And if you haven’t registered for my webinar with BlackRock Smaller Companies trust yet, don’t forget to do so.

The dreaded “taper tantrum” has turned out to be a “taper whimper”, says Will Denyer of Gavekal Research. US Federal Reserve chairman Jerome Powell’s speech at the Jackson Hole conference confirmed plans to cut monetary stimulus later this year. You would expect liquidity-addicted investors to be upset by that prospect, but they took the speech “in their stride”.

Taper yes, rate hikes no

The Jackson Hole “jamboree” had been “looming over the market for months”, says Katie Martin in the Financial Times. The event often sees a central banker “say something silly” that upsets traders. Powell chose to play it safe, allaying concerns about overly hasty monetary tightening.

The Fed is currently buying $120bn-worth of US government bonds and mortgage-backed securities (MBS) with printed money every month as part of its emergency response to the pandemic. With the recovery under way it needs to start cutting back (or “tapering”) that support. But it is a treacherous path: in 2013 a similar move by then-chair Ben Bernanke triggered the “taper tantrum”. The resulting turmoil saw bond yields spike and emerging-market stocks sell off.

Jerome Powell has not repeated Bernanke’s mistakes. He has so far skilfully “avoided miscommunication” of the type that caused the 2013 tantrum, says John Authers on Bloomberg. Stocks rose following the speech; markets had feared Powell might announce a more rapid tightening of monetary policy. Instead, he remained vague on the exact timetable for tapering and made clear that outright interest-rate rises were still a distant prospect. “He managed to couple confirmation that a taper is imminent with reassurance that rake hikes aren’t.” Markets reacted positively. The Nasdaq and S&P 500 indices rose to new record highs. The latter is up by more than 22% so far this year. US government bond yields fell (bond prices move inversely to yields).

How to talk like a central banker

Powell’s speech had “something for everyone”, says Lisa Beilfuss in Barron’s. “Hiring is strong but could be better; the Delta variant may or may not be [a] problem.” Every line that hinted at future monetary tightening “was caveated by a reminder of why it isn’t” imminent. The only theme Powell really insisted on was the idea that high inflation is transient. Much now rests on what happens in September, when economists hope reopening schools will ease America’s labour shortages: “the labour shortage is the root of the everything-shortage” that is driving prices higher. The spread of the Delta variant in America may prove a “wild card” that determines whether that happens or not.

Powell’s speech was an exercise in stalling for time, says Paul Ashworth of Capital Economics. He has resisted pressure from colleagues who want tapering to begin within weeks. We think the Fed will wait until its November meeting “to announce a $15bn reduction in the monthly pace of its Treasury securities purchases and a $7.5bn reduction in MBS purchases”.

Once a year, the world's central bankers have a big get-together in Jackson Hole, which is a resort town in Wyoming, near the Rocky Mountains.

They couldn't do it in person last year, obviously. And unfortunately for businesses in the area, they decided at the last minute to pull it this year too, due to the delta version of Covid.

But they'll be chinwagging remotely in any case.

Everyone whose anyone in central banking will be there. But there's really only one man whose words matter.

That's Federal Reserve boss, Jerome Powell...

Jackson Hole and the Horribly Obvious Metaphor

There's an unavoidable economic analogy to be drawn from this year's Jackson Hole event turning virtual at the last minute. And as it's so obvious, I'm by no means the first writer to draw it. But I'm going to, anyway.

Back in May markets were starting to cool off on the re-opening trade. The economy was running hot, all the talk was of inflation, and investors were starting to get edgy about the idea that central banks might rein in monetary policy a bit.

In short, "tapering" – winding down quantitative easing, basically (we've a short video explainer here) – started to become a big concern.

That's when the Federal Reserve said that Jackson Hole would return to being an "in-person" event - all part of the grand re-opening.

In the months since, even as "taper" concerns have grown, the delta variant has also been chomping its merry way across the globe. In broadly vaccinated countries it has slowed things down.

In broadly unvaccinated countries – many of whom had successfully contained previous waves – it has caused a lot of disruption because even one case can shut down a whole area (Australia and New Zealand being obvious examples here).

So at the last minute, the Fed has made the whole thing virtual.

And really, this just encapsulates what markets are wondering about right now.

Will the strength of the recovery so far and the gains seen in the labour market in particular, persuade the Fed to stick with the idea that re-opening is continuing apace, and so it's probably time to think about stepping away from the money-printing button?

Or will the Fed decide that "delta" has thrown a new factor into the mix, and that it shouldn't be overly hasty on doing anything?

And today is the day that everyone is hoping to find out.

Why the market will be hanging on Jerome Powell's every word

Today's the day that markets hope Jerome Powell will spell out if and when the Fed is going to start tapering off its government bond buying, when he gives his speech to the Jackson Hole attendees.

Markets have been thinking that there might be an announcement at the September Fed meeting. Others think it might be pushed back to the November meeting. As for the taper itself, it might start by the end of the year. Or maybe not.

You'll note that none of this involves actually doing anything. This is all talk about the point at which certain things may or will be done. It's very much about managing market expectations rather than stopping the printing presses dead.

That's how sensitised markets have become to the steady flow of money.

You might well think - why does any of this stuff matter?

The short answer is that it doesn't really. If you are a long-term investor then today will be a potentially more noisy day than usual, but in the big scheme of things it'll represent a blip that you won't notice in six months' time, maybe even six weeks' time.

The more in-depth answer is that it's still useful to know what everyone is going on about and why today might (or might not) cause markets to move around a bit more than usual.

It's no secret that investors would prefer it if the Fed came down on the "let's wait and see side" of the ledger today. And history shows that you can usually rely on the Fed to be more "dovish" than markets fear.

The tricky thing today though is that markets are already pricing in quite a relaxed tone from the Fed. I think Powell would really have to push back quite hard against the idea that tapering is imminent in order to give US markets a boost from their current all-time high levels.

It's perfectly possible that he'll do that of course, in which case the US dollar would most likely go down and most other things go up. But he might also feel it's a bit premature to pre-empt the next Fed meeting.

On the other hand, if he's very aggressive and gives the sense that tapering is in the bag, you'd expect the dollar to go up and most things to go down. But I can't see that one happening either.

So I suspect he'll aim for a non-committal tone - one that won't scare markets but that won't have them piling back into inflation trades again quite yet.

On another note – It is odd that one man can have such market-moving power. It's jarring but true to say that the words Powell chooses to use will have far more impact on financial markets than whatever happens in Afghanistan today, for example.

But that's the system we have, so best to understand it and try to work around it.

We'll have more on all this in MoneyWeek magazine in the coming issues. Get your first six issues free here.

Most market watchers were waiting for the day Covid-19 restrictions would come to an end so they could look for cues as to when central banks would roll back some of the unprecedented support that was given to economies to help them survive the pandemic.

But here we are –15 months later the world is grappling with the spread of Delta, the highly contagious Covid variant which is putting the global economic recovery in doubt.

The UK’s much awaited “Freedom Day” coincided with a global market crash as traders in Asia and on both sides of the Atlantic became increasingly concerned about Delta.

The uncertainty is also apparent in policymakers’ monetary policy, with some of the world’s biggest central banks calling for an earlier tightening because of fears of higher inflation, while others say looser policies must remain in case Delta, among other things, impedes the economic recovery.

Some officials at the US Federal Reserve – the world’s most significant central bank – are calling for an earlier increase in interest rates and tapering of asset purchases, despite the Fed claiming that higher inflation is transitory.

While the “transitory” line was becoming harder to sustain after the US consumer price index shot up by 5.4% in June, and UK inflation jumped to its highest in three years with CPI hitting 2.5% in May, dipping markets and falling bond yields imply that investors are actually getting less worried about inflation.

So how do central bankers plan to try to square this circle?

What the world’s top central banks are saying about monetary policy

The US Federal Reserve

Federal Reserve chair Jay Powell has kept arguing that any rise in inflation is “transitory”, although he did admit in his testimony to Congress last week that inflation is running higher than he had anticipated, and that this may force the Fed to “adjust” its monetary policy if inflation continues to creep higher.

After spending months insisting that it will not raise interest rates above 0.25% until the end of 2023 at the earliest, the Fed changed course and surprised markets last month when it raised its inflation forecast and conceded that we may see some interest rate rises well before the end of 2023.

US president Joe Biden said on Monday that US inflation will be short-lived, but rising long-term inflation would pose a “real challenge” to the economy.

Powell’s term as chairman expires in February and markets are betting that Biden will appoint a successor, so the future of US monetary policy may also depend on who will lead the Fed in coming months.

Richmond Fed chief Thomas Barkin told the Wall Street Journal earlier this month that it is too early for the Fed to consider tapering asset purchases, saying the employment-to-population ratio must climb to 59% from 58% before the bank can even begin considering tapering.

The ratio was 61.1% before the pandemic in February 2020. So it is likely that the Fed may wait a few months at least before starting to taper.

Bank of England

Just like the Federal Reserve, many officials at the Bank of England (BoE) argue that higher prices are transitory.

Andrew Bailey, the Bank’s governor, says a bigger threat is that exaggerated fears over rising prices can impede the economic recovery. The Bank will go through all evidence and assess the extent to which inflation will last, he says.

Not everyone at BoE shares Bailey’s view. Most notably, the Bank’s former chief economist, Andrew Haldane (listen to him on our recent podcast here), warned that the country faces a “dangerous moment” as inflation is likely to hit as high as 4% by the end of the year.

The Bank of England committed in November 2020 to buy the equivalent of additional £150bn worth of government bonds over the next year.

Interest-rate setter Michael Saunders expects the BoE to stop government bond purchases earlier if there is a sharp uptick in inflation, in line with recent comments made by the bank’s deputy governor, Dave Ramsden, who thinks it is likely the bank will reverse the huge monetary stimulus sooner.

The Bank of England is due to announce its next monetary policy decision on 5 August and is expected to issue fresh forecasts for the UK economy.

What are other central banks doing?

The central banks of most other major economies are following a similar trajectory to that of the UK and the US.

The Bank of Canada kept interest rates stable at 0.25% and cut its weekly net purchases of Canadian government bonds to a target of two billion Canadian dollars.

While the central bank’s governor Tiff Macklem expects inflation to remain above 3%, the Bank of Canada expects it to fall back to 2% by 2022. Like the US, Macklem believes inflation will be transitory.

The Reserve Bank of Australia said it would extend the length of its bond buying programme to mid-November this year although the central bank cut its bond buying programme to A$4bn a week, down from A$5bn. It also kept its interest rate steady at 0.1% and is not anticipating any interest rate rise until 2024.

But not all central banks are nervous about a stronger than expected recovery. The European Central Bank (ECB) changed its target earlier this month to allow inflation to overshoot. This marked the central bank’s first review since 2003. Prior to this, the ECB’s current target was to achieve inflation of “below, but close to, 2%”.

But now the official inflation goal is going to be 2%, with overshoots allowed to take place. In other words, it explicitly allows for an even softer policy stance, says Holger Schmieding, chief European economist at Berenberg.

It also reduces the likelihood of central banks raising interest rates. The Fed also changed its inflation targeting approach at the Jackson Hole Symposium last year.

One important central bank further loosened policy earlier this month. The People’s Bank of China made it easier for banks to lend more money by cutting the amount they need to hold in reserve. In technical terms, the Chinese central bank cut the reserve requirement ratio (RRR) for banks by 0.5 of a percentage point, effective from 15 July. That paves the way for banks to release another $150bn into the economy.

While inflationistas are sounding the alarm about rising prices in the US, a very different situation is happening in Japan. Japan’s economy is facing deflationary pressure and prices fell 0.1% in May compared to the previous year. The country, which has a history of battling deflation for more than two decades, has never hit its long-time goal of achieving 2% inflation.

The Bank of Japan kept its yield-curve control target at -0.1% for short-term interest rates, and ten-year Japanese government bond yields at 0%.

So now that we have caught a glimpse into the monetary policies of some of the world’s most powerful economies, what does this mean for investors?

What all this means

Markets spent the first few months of last year fretting about the pandemic, hitting rock bottom last March. Then, when chatter about Covid vaccines surfaced, markets recovered at the end of 2020. As countries including the UK, Israel and the US embarked on robust vaccination programmes, markets soared again and hit record after record in the first few months of 2021.

The overall future direction of central banks’ monetary policies depends on whether countries can bring the virus under control – whether hospitalisations and deaths stay constant or fall.

However, even if that happens, it is likely that most central banks will be extremely wary of rolling back the cheap money and vast stimulus measures that have been in place for much of the year. That in turn increases the odds that they’ll act too little, and too late.

Inflationistas received their latest sign on Tuesday that the US economy is overheating and inflation may not be so transitory after all.

Consumer prices rose 0.9% between May and June, said the Bureau of Labor Statistics showed.

This was much higher than economists at Bloomberg were predicting; they had estimated that prices would rise by just 0.5%. But Tuesday’s reading marked the highest one-month change in 13 years, since June 2008.

The consumer price index (CPI) rose 5.4% in June, the fastest pace since August 2008. That was also higher than the 5% rise in May and also beat economists’ predictions of a 4.9% rise.

Excluding volatile components such as energy and food, core CPI jumped to 4.5% in June year-on-year, surpassing the 3.8% reading in May.

Why is US inflation so high?

Market watchers have long been scrutinising US inflation figures for signs of whether the Federal Reserve – the US central bank – will gradually begin to reduce the extraordinary stimulus measures it took during the pandemic and trillions of dollars’ worth of stimulus it has pumped to help the economy survive the pandemic.

After spending months insisting that it will not raise interest rates until 2023, the Fed changed course and stunned markets last month when it raised its inflation forecast and conceded that we may see some interest rate rises by the end of 2023

A third of the rise in CPI last month came from a surge in second-hand vehicle prices, which rose by 10.5% in June compared to May.

The higher prices were also evident in used airline fares, hotel room rates and many other sectors that were hit hardest by the pandemic.

“The June CPI report showed that everything is getting more expensive for the US consumer… Wall Street reacted strongly to a hotter than expected CPI data that sent short-end Treasury yields higher,” said Edward Moya, chief market analyst at OANDA.

All eyes will now be on Fed chair Jerome Powell’s testimony on Thursday and Friday when he is due to appear on Capitol Hill and give an update on the future state of monetary policy.

Tuesday’s reading also makes it harder for Powell to advocate that looser monetary policies still need to remain in place.

US stocks fell at their open after the inflation data was released.

The strong reading raises odds of an earlier tapering

Tuesday’s strong inflation reading also raises the odds that the Fed may make a taper announcement –effectively indicating when it may start rolling back $120bn of bond purchases – at the Jackson Hole Symposium in August.

“A lot of this still looks transitory, but if prices continue to stay elevated, the Fed will have to concede that parts of the surge prices will be transitory,” adds Moya.

Ben Laidler, global markets strategist at multi-asset investment platform eToro, says June’s figures may reverse a sharp decline in both inflation expectations and ten-year yields as the market anticipates an earlier loosening by the Fed.

“We may also see renewed interest in more cyclical and deep-value sectors, such as financials and commodities, at the expense of the high-flying tech sector,” adds Laidler.

So hate it, loathe it, accept it or deny it, inflation is creeping up. So the best thing for investors to do is to inflation proof their portfolios.

The big economic event last week was US inflation data. In the end, it all panned out calmly. Inflation was a bit higher than expected, but markets shrugged it off.

This week’s big event is the Federal Reserve’s reaction to it all.

So what’s likely to happen, and what should you keep an eye out for?

The week’s biggest event

On Wednesday this week, the Federal Reserve announces its latest decision on monetary policy. In the UK, we’ll hear about it after the market’s closed for the day.

Investors will want to see what the Fed’s current thinking on inflation is. Is the Fed still comfortable with the idea that inflation is transitory? Or is it getting edgy? Will Jerome Powell say that it’s time to start thinking about tapering? Or will he wave it all away as nothing to worry about yet?

Like it or not, this could have a big market impact – in the short term at least. As I’ve said more than a few times in the past, it’s odd to think that so many prices in so many different markets all across the globe can be moved so sharply by the prognostications and eyebrow twitches of a handful of people in a room somewhere. But that’s the system we live with.

Clearly, we’re not mind readers and we have no crystal balls. And in the end, if you’re genuinely a long-term investor, this sort of event shouldn’t faze you. If your portfolio can’t endure the tiny bit of potential turbulence caused by a single economic data release, or an unexpected sentence in a Fed statement, then you need to revisit your strategy.

However, unless you plan to ignore the news entirely (I actually think this is a good strategy 99% of the time – it’s just one that a lot of people struggle to enact), then it’s useful to understand what’s going on.

When you have a rough idea of what to expect from various events, then it can help you to keep control of your own emotional reactions to swings in the market. If you can minimise the element of surprise, you can also minimise your propensity to panic.

So what’s the likely outcome here? When it comes to binary (or near-binary) decision making, you have to assume that people will take the path of least resistance. You just need to work out what that is.

The good news is that right now, it’s still pretty obvious.

Always pick the path of least resistance

There are really only two options here. Option one is that the Fed could start talking tough on inflation, and saying that it wants to tighten monetary policy earlier than markets expect. Option two is that the Fed keeps to its “we’ll watch and wait” mantra.

Inflation is becoming more of a talking point. It’s very clear that there are cost pressures out there. However, it’s also very far from clear that it’s a long-term problem. I think it will be, but that’s certainly not the consensus view right now, either in markets or in the press.

And loath as I am to admit it, that’s perfectly reasonable. There is more than enough confusion in the data to allow room for debate. You can still make the case that inflation will be “transitory” (and there are still quite a few smart people who reckon we’re in for yet another deflationary dip – I’m not in that camp but I respect many of those who are).

You just need to look at the reaction to last week’s higher-than-expected inflation data to realise that markets are currently willing to believe that this is temporary. Gold is drifting lower. US bond yields actually fell (you’d expect them to rise if inflation was really viewed as a long-term issue).

So here’s what could happen.

If the Fed goes for option one, markets will panic, the dollar will strengthen and most other things will go down, including the US stockmarket. And interest rates might well spike (at first) which is the last thing they want.

They’ll get push back from “opinion formers” too. People will wonder why the Fed is already talking about tightening when unemployment – which it says is the priority – is still so high. The Fed will have to explain its views. It’ll be like kicking a hornets’ nest.

If the Fed goes for option two, then markets will remain broadly on their current path, which for most markets is either meandering around, or steadily edging higher. The opinion formers will be calm. The Fed won’t have to explain anything – it’s easy to stick to the “transitory” argument for a while yet.

In short, the Fed can easily kick this debate along the road until at least the depths of summer. It can then use the annual central bankers’ conference at Jackson Hole to start warming markets up to a “taper” if it feels it necessary to do so.

Which of those options is the path of least resistance? Option two, clearly. So your only real concern there is whether Powell speaks with enough “dovish” intonation to keep markets calm. I suspect he’ll err on that side of things – he’s had enough practice by now.

Indeed, if we get any surprises at all I imagine it’ll be that the communication is even more relaxed than anyone expects. But we’ll see what happens on the day.

And if you haven’t already subscribed to MoneyWeek magazine, get your first six issues free here.

The US government is running “an inflation experiment”, says The Economist. President Joe Biden is pushing for $4trn of new spending on infrastructure and social programmes. On the monetary front, the US Federal Reserve is more relaxed about inflation exceeding its target of around 2% than it used to be.

The Fed learns to love inflation

America’s consumer price index (CPI) rose by 2.6% on the year in March. The monthly increase of 0.6% was the biggest in nearly a decade. UK inflation has been more subdued but is also heading higher; prices rose by 0.7% in March year-on-year, with inflation forecast to hit or breach the 2% target by the end of the year.

The US economy is booming, expanding at an annualised rate of 4% in the first three months of the year and likely to grow even faster in the current quarter. Yet the Fed has refused to cut back on crisis measures, especially its $120bn in monthly quantitative easing (QE)-funded asset purchases.

That is partly because Fed chair Jerome Powell is waiting for employment to recover, says Justin Lahart in The Wall Street Journal. There are still 8.4 million fewer American jobs than before the pandemic, although recent jobs growth has been impressive. He also insists that current inflation is “transitory”, driven by growing pains as the economy reopens and a weak comparison period last year.

Many investors remain relaxed: they think Powell will rein things in if inflation really surges. But the Fed has made it clear “that it is in no hurry to tighten”. They should listen to what the Fed actually says, not what they wish it would say.

Big Business hikes prices

Signs of the new inflation are everywhere, says Jeremy Warner in The Daily Telegraph. Copper prices have topped $10,000 a tonne for the first time in over a decade, shipping rates have soared and computer chips are hard to come by. The unprecedented scale of fiscal and monetary stimulus in the rich world will turn into inflation once economies fully reopen.

Firms are already hiking prices, say Judith Evans and Emiko Terazono in the Financial Times. Consumer goods giants such as Nestlé and Unilever point to soaring input costs. Palm oil prices have doubled since spring last year. Packaging costs are up by almost 40% since the start of 2020. In Europe, milk prices have soared by about 50% so far this year. Consumers had been insulated from these price surges because big firms use hedging contracts to keep their input costs predictable. Yet as those contracts expire prices will climb.

US executives have mentioned the word “inflation” more frequently in their latest earnings conferences than at any time since 2011, says Lu Wang on Bloomberg. Not that they’re worried: the net margin of S&P 500 firms has hit its highest-ever level, according to Bank of America. That is a testament to the pricing power of big business, which is able to pass higher costs directly onto customers. For now at least, corporate earnings are thriving in the era of higher inflation.

Last week, US Federal Reserve chair Jerome Powell made his views on bitcoin clear: it’s “an asset for speculation”, one that “is essentially a substitute for gold rather than for the dollar”, Powell told the Bank for International Settlements’ digital banking conference. Nor is it “a useful store of value” because of its volatility.

Powell’s comments are perhaps unsurprising. You wouldn’t expect the governor of the world’s most important central bank to say: “rush out and buy bitcoin”. Yet his views are not necessarily shared by Wall Street, with the likes of BNY Mellon and Goldman Sachs taking bigger steps into the area of cryptocurrencies in general.

It’s little wonder that institutions are becoming more interested. Bitcoin has now been around since 2008; in that time it has survived several boom and bust phases, and in each boom phase, people have potentially made a lot of money.

Today, despite all the scepticism, it remains trading close to its recent all-time high of $61,644, thanks to a search both for inflation hedges (given the scale of public debt and money being printed by central banks) and, for returns in a low-interest rate environment coupled with frothy equity and bond markets, points out Anthony Hardy, research analyst at Franklin Equity Group.

So are cryptocurrencies becoming mainstream – and should you invest?

Banks are turning bullish on crypto

Mainstream adoption of cryptocurrencies is growing fast. Since the start of the year, several big banks have embraced crypto. Goldman Sachs, for example, reintroduced plans to launch a cryptocurrency desk for futures trading.

It’s not alone. Just a few months after America’s oldest bank – Bank of New York Mellon – announced it will roll out a new digital custody unit later this year, Morgan Stanley became the first bank to give its wealth management clients access to three cryptocurrency funds, according to CNBC.

Meanwhile, in a 108-page report published in February (which came in for some criticism), Citigroup gave bitcoin a big endorsement, saying that it “may be optimally positioned to become the preferred currency for global trade”.

It is not just the banks who are increasingly endorsing crypto. Tesla’s Elon Musk started accepting bitcoin as payment for cars earlier this month, just a few weeks after Tesla shifted $1.5bn into bitcoin.

The crypto rally has also captured the attention of individual investors who view bitcoin as a potentially better hedge against inflation than traditional hedges such as gold, primarily because bitcoin has a fixed long-run supply of 21 million coins, compared to central banks’ ability to print as much fiat currency as they like.

The US recently approved a $1.9trn stimulus plan which market participants think may be seen as the tipping point for inflation to stage a comeback (and now Joe Biden’s administration is pushing for a further $3trn spending plan). And with the Fed signalling that it won’t raise rates until 2024 at the earliest, inflation is very much at the fore of investors’ minds.

Why bitcoin may not be the best hedge against inflation

But are people really buying bitcoin because they think it’s a good hedge against inflation? Bank of America doesn’t seem to think so. “Bitcoin has… become related to risk assets, it is not tied to inflation, and remains exceptionally volatile, making it impractical as a store of wealth or payment mechanism”, Bank of America’s commodity and derivatives strategist Francisco Blanch, said in a recent note, according to CNBC.

Economist Nouriel Roubini – renowned for his bearish views and a long-time critic of digital currencies – agrees. “If people were really worried about inflation they would diversify in a wide range of assets that are historical good hedges against inflation. That's not happening”, he says.

Another point is that, while bitcoin does have a fixed supply in much the same way other assets viewed as inflation hedges such as gold, it’s still possible to launch competing cryptocurrencies which can expand the market, argues Daniel Kern, chief investment officer at TFC Financial Management.

Should you invest in cryptocurrencies?

Discussions about cryptocurrencies can be quite polarised. True believers get very defensive, while ardent crypto critics act as though the whole thing is on the verge of collapse. We take more of a middle view.

Ignoring crypto seems unwise. It’s clear that digital currencies and the blockchain are of great interest to governments and central banks. And bitcoin has now managed to survive enough booms and busts to convince us that it’s not a flash in the pan. So investors should pay attention to the space and educate themselves on it.

In a recent issue of MoneyWeek magazine, Charlie Morris made the case for holding both bitcoin and gold as hedges against different stages of inflation – he believes they complement rather than compete with one another.

Equally, if you’re not an early adopter or particularly tech-minded, we wouldn’t worry too much. If crypto becomes significant enough to be considered an asset class in its own right (rather than an evolution of currencies, say), then institutional adoption will eventually lead to investment vehicles that are more easily accessible to private investors.

If you’re interested to learn more about bitcoin generally, then you can currently get a free beginner’s guide to bitcoin when you subscribe to MoneyWeek. Get the report, plus your first six issues, absolutely free here.

Last night’s meeting of the US Federal Reserve was – for markets at least – probably the most important it's had since the peak of the Covid-19 crisis.

As we've been writing about for a while, markets are a bit nervous. Investors are happy that the global economy is recovering and bouncing back, and that's all good news for corporate profits (overall, at least). But recovery also means something else.

Firstly, it means the economy is stronger and so it doesn't need as much support from central banks. Secondly, there's also the risk that prices rise quickly because of lots of demand hitting bottlenecked supply. If inflation takes off – which investors increasingly expect – then that also implies tighter monetary policy.

The Fed is promising markets that it won't lift interest rates for a long, long time

Markets have grown used to a very supportive central bank. But, if the Fed starts to tug that support away, can they cope? A similar question arose in 2013, and we got the “taper tantrum” which then forced everyone involved to start rowing back hard.

It's clear that the Fed has learned its lesson from that and countless other little tantrums in the past. Fed chief Jerome Powell yesterday made it very clear that a) he's supremely relaxed about inflation, and b) it's good to see the economy recovering, but there's a long way to go.

The Fed did increase its expectations for US growth this year; it also expects unemployment to go down faster than thought previously. So the central bank reckons 2021 will be a good year for the US. However, it also made no real change to its own interest-rate expectations. It still doesn't expect interest rates to be above zero before 2024.

In short, the message is: the economy is going to recover, and that's good news, but we don't see any pressing need to raise interest rates for a good long while.

That's what the market wanted to hear. And in his press conference, Powell pushed the message more aggressively. He said, yes, inflation is likely to be higher in the next 12 months, but emphasised that it's all “transitory”. In other words, the Fed won't pay it any heed. He also focused closely on unemployment being too high, and made it clear that getting this down is the Fed's priority.

As John Authers puts it in his Bloomberg letter: “Powell was telling everyone that the Fed now cares more about unemployment than inflation, and that there's no need to worry that the likely inflation scare over the next few months, as the great shutdown passes more than 12 months into the past, will shake the [Fed] into tightening monetary policy.”

The immediate result was not surprising. The US dollar weakened (if interest rates are going to be stuck to the floor for longer, it usually means a weaker currency); stockmarkets shot up (they like a weaker dollar); bitcoin surged. Even gold, which has been mired in its own slough of “risk-on” despond recently, managed to perk up above $1,740 an ounce. And yields on long-term bonds continued to rise, steepening the yield curve.

What if the Fed is underestimating inflation?

Put simply, the Fed is saying that the economy is heading for a healthy reflation. So you get growth coming back and long-term interest rates rising a bit, but you don't get the sort of lasting surge in inflation that undermines all that growth. So the Fed can afford to stand back for a while longer and not worry about tightening monetary policy.

This is the “Goldilocks” scenario, and for now investors are reassured that the Fed still believes in it, and plans to act as though it's the case. It also suggests that the various “reflation” trades – particularly bank stocks – should keep doing well.

It's important to keep an eye out though. The biggest question is: how much inflation can the Fed ignore? And at what point might it have to do something more aggressive than talk about ignoring inflation?

As Michael Pearce of Capital Economics points out, this is the main risk to the Fed's forecasts. “Surveys suggest rising price pressure are broad-based, wage growth is elevated given the spare capacity in the labour market, and inflation expectations have trended higher over the past year”.

If inflation doesn't drop back or surges more powerfully than expected, then the Fed will have to come back and convince the market all over again that it's not going to act. That's when things start to get more interesting, and not necessarily in a comfortable way.

Anyway, we'll be writing a lot more about that in the coming issues of MoneyWeek magazine. You can get your first six issues plus a beginner's guide to bitcoin absolutely free here.

While we’ve been distracted by this week’s budget, things have been going a bit pear-shaped over in US markets.

It’s a continuation of the same problem we saw last week. Bond yields are going up, because investors think that the recovery will be better than expected. In turn, that will put pressure on the Federal Reserve to raise interest rates or tighten monetary policy in some way.

Yesterday, markets were hoping that Fed boss Jerome Powell would say something to calm them down. He tried. But at this stage, just talking isn’t quite enough.

Here’s why “jam tomorrow” stocks are struggling

The tech-heavy Nasdaq index in the US has now entered correction territory. It’s down 10% since its most recent high, which came less than a month ago, on 12 February. The S&P 500, less reliant on tech, is down about 5% over the same period.

Over here in the UK, by contrast, the FTSE 100 is down by about 2% over the same period (though it peaked for the year back in January, since when it has fallen by about 4%).

What’s going on? Well, it’s what we’ve been discussing for a while now. Markets expect the economy to rebound hard now that we have vaccines and the global economy should re-open before the end of the summer and hopefully be well on the way to “normal” before the end of the year. As a result, they’re expecting prices to go up too. And if the recovery is strong enough, inflation might even become an issue again.

That’s all great news for the economy and for the “real” world. But it’s a bit trickier for the financial realm. If the economy is stronger, then central banks would normally be thinking about raising interest rates a bit. That’s not good for those markets which have become extremely expensive on the assumption that interest rates would stay low forever.

The worst-hit assets have been “long duration” plays, or what I’m constantly calling “jam tomorrow” stocks. Tesla, for example, is down by nearly 30% from its highest point this year. The electric-car maker is a stock whose valuation is predicated on hopes and dreams of a glorious future. But because that future is so far away, any change in the discount rate (the number you use to adjust the value of future earnings) has a much bigger effect on the present value of those future earnings than on some boring oil pumper like Exxon, say (you can read more about the mechanics of this in my earlier piece here).

So when Jerome Powell, the head of the Federal Reserve had a chat with the Wall Street Journal yesterday, the market was hoping that he’d say something reassuring, about how he wasn’t planning to even think about raising interest rates until and unless inflation was really going for it and America was at full employment.

The thing is, that’s basically what Powell said. He said: “We will be patient. We’re still a long way from our goals.” But the market still sold off. Why? Because he wasn’t specific enough.

The market will need to throw a bigger tantrum

Investors want the Fed to put a number on all this. They want to know that the Fed will act to keep rates down within certain parameters. In effect, investors are starting to price in earlier tightening than they’d previously expected. And that can’t help but have an effect on stocks (and bonds) that had been priced for a longer period of ultra-loose money.

Really, what they want is for the Fed to make an explicit commitment to something like yield curve control (where the central bank says that it simply won’t let long-term government bond yields rise above a certain rate). But the Fed hasn’t done that yet, and because the market is starting to believe that inflation will be higher than the Fed expects, they don’t think the Fed will hold out.

And the reality is that the bond market – I mean, you could call them “bond vigilantes” if you wanted though it’s a little melodramatic – will probably keep pushing yields higher until either investors decide that they’ve gone far enough for now (ie that they’re pricing in all the inflation they expect) or the Fed decides that enough is enough.

What’s likely to drive that? At the moment what we’re seeing is a shift from one sector of the market to another. As is clear from the figures above, the Nasdaq is having a tough time, but other markets aren’t doing too badly. Value is beating growth. Oil stocks are rallying hard in the face of full-on ESG adoption. The market is doing its usual thing – tipping the boat over just as everyone was looking over the side.

If this continues to simply be a rotation, the Fed may not need to even get involved. The problem is if it starts to spread to the financial plumbing. For example, maybe bond investors – normally the sober ones at the party – will panic and decide that it’s actually just been one big bubble and start selling hard rather than simply driving yields back up to “sensible” levels. I mean, there’s been a sniff of panic in the air recently – if that goes full blown, then the Fed might react.

Or of course, stocks might fall hard. That’s a distress call that central banks have previously struggled to ignore. As Eoin Treacy notes on FullerTreacyMoney.com, “with the S&P 500 down less than 5% from an all-time peak, the Fed has no incentive to act. When it is down 10% or even 20%, then we will see how sanguine the Fed is.”

In other words, we need to see another tantrum before the Fed feels justified in acting. While we wait for that, I’d just keep an eye on your watchlist, see if anything you want to buy becomes available more cheaply, and invest when it does. And I’d stick to the plan of value over growth, investing in energy stocks and financials, and opting for international over the US.

For more on all this (we’ve been talking about it for a while after all) make sure you subscribe to MoneyWeek – get your first six issues (plus a beginner’s guide to bitcoin) free here.

Get ready for a boom. Starting next week, the UK is rolling out a vaccine for Covid-19. That has to be good news for the economy – it marks the beginning of the end of lockdowns. And in fact, it might be much better news than anyone expects. Some have suffered far more than others as a result of lockdown, but it is clear that, on aggregate, it has been good for household balance sheets on both sides of the Atlantic. As Richard de Chazal of wealth manager William Blair notes, in the US last quarter “debt as a percentage of disposable personal income fell to its lowest level in a quarter of a century”. In other words, there’s a lot of money out there waiting to be spent.

Some naysayers point to surveys suggesting that consumers plan to maintain the savings habit once lockdown is over. But after a year of no holidays, no eating out and no high street shopping sprees, how inclined to fiscal prudence will we really feel? We suspect this is one of the few occasions where the phrase “pent-up demand” has genuine meaning. So the stage is set for a short-term boom as all that delayed demand floods out in the early part of next year. But what happens then? Why will this be anything more than a short-term sugar rush?

Governments and central bankers entwined

The key rationale for not just one good year, but an entire “Roaring ’20s”-style decade, is that this is the era when we finally throw off the deflationary fog that has hung over the global economy since the financial crisis, and enter a much more inflationary period. This will bring its own problems – financial repression, the policy of holding interest rates below inflation, will squeeze a lot of portfolios. But in the meantime, growth will heat up, and assets that lost out in recent years will see their fortunes reverse. The clearest marker of this new dawn came this week, as incoming US president Joe Biden nominated Janet Yellen, who preceded Jerome Powell as head of the Federal Reserve, for the post of treasury secretary.

That is incredibly significant. For about a decade now, central bankers have been complaining that they can only achieve so much with monetary policy. They need governments to help by directing the spending of all the money they have been printing. This complaint has only grown louder amid the economic damage wrought by lockdown. Now the former head of the world’s most powerful central bank will be running the fiscal policy of the world’s most important economy. Congress might be gridlocked, but it’s hard to believe that Yellen won’t have the clout to drive through at least moderately ambitious spending plans. We’ve already seen a reaction from US bond markets – long-term interest rates, which have been nailed to the floor all year, began to rise this week.

Meanwhile in the UK, while Chancellor Rishi Sunak might be jittery about our high levels of debt, he’s not exactly keen to do anything about it. Tax rises or spending cuts will be driven by politics, rather than any effort to reduce debt. So we may well see a hike in capital gains taxes for the sake of targeting “the rich”, but don’t expect that to make a dent in the national debt. Instead, central banks will be underwriting government cheques for years to come. Where will the money go? There are lots of ideas out there (politicians can be very creative with other people’s money) but the overarching theme across all corners of the globe is that of a “green” infrastructure boom. Unlike many forms of debt relief (which we may eventually get too), it’s uncontroversial – try opposing efforts to tackle climate change and see where it gets you – and so it’s the perfect excuse for governments to spend.

Does that mean you should be investing all your money into wind farms and hydrogen? We’ve looked at ways to invest in the green sector in recent issues (and if you’d bought any of our hydrogen tips earlier this year you’ll already be sitting on some very healthy gains). However, a lot of growth is already priced into many of these assets – arguably electric car manufacturer Tesla is the standout stock of the “green tech” boom, and, whatever else you can say about Tesla, you can’t argue that it’s cheap. So while there’s potential for decent returns from “green” stocks, and you should have exposure, that’s not where we want to focus this week. Instead, two main areas, with a certain amount of overlap, look particularly promising (and cheap) now – commodities and value.

Investing in the new commodity supercycle

One beneficiary from a Roaring ’20s should be the commodities market. Put simply, under-investment (due to a long bear market in commodity prices) has hit supply, while demand is set to spike due to infrastructure spending. That should drive prices higher and be good for producers. The commodities and natural resources investment trust sector is small, with seven trusts in all, according to the Association of Investment Companies. Three are specialists. Riverstone Energy is shifting strategy from oil and shale assets towards renewables; Geiger Counter (LSE: GCL) focuses on uranium; and Golden Prospect Precious Metals (LSE: GPM) focuses tightly on gold and silver miners. Both of the latter are good bets for investors looking for exposure to those specific sectors – Riverstone might represent a good bet but those looking for exposure to oil might be better with the iShares Oil & Gas Exploration & Production exchange-traded fund (LSE: SPOG).

If you’re looking for wider exposure, that leaves four trusts. Baker Steel Resources (LSE: BSRT) runs a very concentrated portfolio (about 85% of the trust is invested in ten holdings) of mostly unlisted natural resources companies. It trades on a discount of around 10% to its net asset value (NAV) – the ten-year average is 25%. About half of the portfolio is in precious metals. For a less concentrated (and thus less risky) fund, BlackRock World Mining (LSE: BRWM) trades on a discount of 8% and pays a 5% dividend. About a third of the portfolio is in gold miners, another third in “diversified” miners, and a fifth in copper.

An even wider spread can be found in CQS Natural Resources Growth & Income (LSE: CYN), which has a lower weighting towards gold, but significant exposure to shipping, as well as a little bit of lithium and palm oil exposure. It’s on a 16% discount and offers a dividend of about 5.5%. An alternative which gives exposure both to the commodities boom (half its assets are in mining, and about 20% in conventional energy) and the green infrastructure trade (about 30% of the portfolio) is BlackRock Energy and Resources Income (LSE: BERI). It trades on a discount of around 13% and pays a dividend of just over 5%. For more explicit protection against financial repression, own some gold. And perhaps a small allocation to bitcoin – just in case.

The return of value

Value (cheap stocks) has been underperforming growth (expensive stocks) for a long time. From a big-picture perspective, that’s been driven by the belief in “secular stagnation” – a future of weak growth, low inflation, and low interest rates. But after a few false dawns, it looks as though the vaccine news might have been the trigger to turn this view around. So what are the most obvious beneficiaries of a “great rotation”?

Goldman Sachs makes the case that even the US S&P 500 – currently more overvalued than at almost any point since the dotcom bubble – will go above 4,000 by the end of next year, as neglected value stocks catch up with the Big Tech stocks that have led the market for the past few years. But if you’re looking for actual value as opposed to relative value, there’s one place that should still be first on your shopping list – the UK. The FTSE 100 is more stuffed with value stocks (such as commodities and financial stocks) than any other major index in the world. Throw in the fact that, one way or the other, Brexit is going to be resolved soon – meaning that global fund managers will find it harder to simply ignore the UK – and a lot of money could be flowing the UK’s way soon.

You could buy a simple FTSE tracker fund to benefit. Actively-managed options include Fidelity Special Values (LSE: FSV) which has 80% of its portfolio in the UK, pays a dividend of around 2.5% and trades at a slight premium to NAV, or MoneyWeek portfolio pick Law Debenture (LSE: LWDB), which yields 4% and trades roughly at NAV (see page 24 for more ideas). Or you could go for a “best of both worlds” global trust that has already done well from the great rotation: Monks Investment Trust (LSE: MNKS). As Citywire notes, while it still holds plenty of growth stocks, since April, Monks’ managers have moved part of its portfolio into recovery plays, including London-listed miners and global travel stocks. As a result, in the six months to the end of October it returned 25.7% (with dividends). It trades on a small premium to NAV.

A spat has broken out between the Federal Reserve – America’s central bank – and the US Treasury department. Steve Mnuchin, the US Treasury Secretary (equivalent of the chancellor over here), has told the Fed that he won’t be renewing some of their emergency lending facilities after they expire at the end of next month.

The US central bank, meanwhile, retorted it "would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy."

Is this a fit of pique by a tantrum-throwing outgoing administration, or is there a bit more to it than that?

Why the US Treasury is falling out with the Federal Reserve

You don’t often see public spats between the US Treasury and the Federal Reserve. In fact, you don’t generally see many arguments between central banks and governments. They prefer to play along nicely together.

But of course, the current US government is on its way out (presumably). A certain amount of chaos was always possible, and the idea that the Trump administration might make it harder for the Fed to support the economy while Joe Biden is getting ready for his turn in the hot seat has certainly rattled markets – though not massively.

So what’s happened? Mnuchin wrote to Fed boss Jerome Powell saying that, while four of the central bank’s emergency lending schemes would be extended for 90 days, he wanted the other five to end on 31 December, as scheduled. And he wants the unused funds back too – a mere $455bn. The Fed immediately said that it would rather keep hold of the money.

Markets were a little rattled after the news: US government bonds rose a bit (ie, yields fell), stocks fell from their highs, and the dollar popped a bit higher. Nothing dramatic, but a wee shiver nonetheless.

What’s the rationale? At first it might seem like an outgoing government is just sticking the spokes in the wheels of the incoming one, but it looks like there’s more to it than that. The five schemes that are being shut down on schedule (despite rising Covid-19 cases in the States) are two of those set up to buy corporate debt; the “Main Street Lending Program” for lending to medium-sized businesses; a scheme for lending to local governments; and one to prop up asset-backed securities (such as mortgage-backed bonds).

The four that are being extended are the ones that prop up markets for lending short-term money – such as the commercial paper market (where companies can borrow for very short periods for working capital and the like).

Why scrap the other funds? The reality is that, as the FT points out, “only a small fraction of the available lending capacity was used.” Why? Mainly because the Fed’s other schemes were so effective. “Some companies and local governments ended up securing better funding terms through regular capital markets”, notes the FT, while some businesses found the terms of the Fed facility too strict.

Taking from the central bank to give to the politicians

You might argue that a "belt and braces” approach is more important – why the urgency to end the schemes? But the problem right now is that what the US really needs – if anything – is extra money from the government to compensate people and businesses for lockdowns. That’s difficult just now because not only is the US between governments, it’s also still going to be divided when Biden takes over. So it’s always going to be hard to agree on further spending.

What’s interesting here is that, by taking this money back from the Fed, it frees the cash to be spent elsewhere by Congress. Long story short, the money was already in the budget, so it’s not “extra” cash that they have to pretend to find somewhere. It can be spent with impunity and a lot less political jockeying. In other words, by taking this money from the Fed, Mnuchin both puts pressure on Congress to take action, and hands them a big chunk of money to do it with.

It’s a charitable interpretation, but it’s also the one that makes most sense, and it explains why markets haven’t exactly cratered. As Mnuchin put it in an interview with Bloomberg, companies that are really struggling with the pandemic need grants, not debt: “The economy has responded very strongly, but there are still areas of the economy that need more support. That’s why I’m encouraging Congress to reallocate this money.”

Bloomberg adds, “presumably it will be significantly easier to sell Congress on appropriating these funds rather than working towards a bipartisan fiscal aid package, which has remained elusive for months and which President Donald Trump might not support anyway.”

So what’s the upshot? Don’t get me wrong. If the Fed’s ability to prop up markets was inhibited by the outgoing Trump administration, then Biden would be coming in against the backdrop of a massive market crash. That wouldn’t achieve much – it’s unlikely to be blamed on Biden after all – but maybe you're jaded enough to believe that Trump might just enjoy a scorched earth outcome.

However, I don’t think that’s what’s happening here. And it’s pretty clear that markets don’t either. We’ll see what happens but I think if anything, it just confirms that the reflation trade remains the outcome to bet on right now.

We’ve more on all that – and I also write about when it might be time to start being more circumspect – in the latest issue of MoneyWeek magazine, out now. Get your first six issues free here.

Joe Biden is almost certain to be the next president of the United States. Donald Trump may fight for every inch, but unless there’s a huge surprise, then, come January, Biden will be sworn in. How much does that matter for investors?

Despite all the fuss that gets made about it, the occupant of the White House matters far less than lots of other factors. But there’s no doubt that a Biden presidency will be better for certain sectors, and worse for others, than a Trump win. So what should you be taking into account?

The state of the nation

The first question is how the land will lie once the dust has settled. It looks as though the Senate will stay in the hands of the Republicans. So Biden probably won’t be able to spend as much as he’d hoped on a “green new deal”. However, it suggests that we won’t see huge changes to taxation either. As John Higgins of Capital Economics notes, even if the Democrats do manage to take the Senate with “the slimmest of majorities, their more moderate senators would probably limit Biden to a more centrist legislative agenda”. So while less may be given with one hand, less will be taken away with the other.

Of course, there are variations within that basic template. Whatever your views on him, Trump was undoubtedly a divisive leader, even within his own party. Some Republicans might be keen to distance themselves from him, and thus more willing to cooperate on certain issues – particularly as Biden has a reputation for bipartisanship, having worked closely with Mitch McConnell, the Republican Senate majority leader, in the past. In that case we might get more spending than expected. Alternatively, perhaps the Republicans may decide that continuing down the “Trumpism” route (albeit perhaps without Trump) is the key to winning in 2024, in which case they may be more obstructive than expected. If that happens, the Federal Reserve – America's central bank – will feel the need to step in and do more of the heavy lifting to prop up the US economy.

Fed boss Jerome Powell has already warned US politicians not to tighten the purse strings. In a pre-election speech, Powell urged the government to keep supporting businesses and unemployed workers through the pandemic. “Fiscal policy can do what we can’t, which is to replace lost incomes for people who are out of work through no fault of their own.” That said, Powell and the Fed are by no means powerless even if gridlock does prevent any further stimulus packages from being passed in the short term.

The Fed can still do yield curve control (pinning long-term bond yields to a specific low target – perhaps zero, as the Bank of Japan is already doing); it can still decide to buy lower-quality assets with quantitative easing – eg, copying the Bank of Japan again, in buying equity exchange-traded funds (ETFs); or turn interest rates negative (just like – you guessed it – the Bank of Japan). And even if Biden chooses to replace Powell, then his most likely pick for Fed governor will be someone even more inclined to money-printing, such as Lael Brainard, who is currently seen as his top pick for Treasury secretary.

So the only real question is how much fresh money comes in via the fiscal route, direct from the government (in which case it’s likely to be more inflationary), and how much comes in via the central bank route (which means it’s more likely to boost asset prices but not necessarily inflation). That said, some extra spending seems all but certain – we won’t see a return to fiscal conservatism any time soon.

What can Biden do?

Assuming that the balance of power implies gridlock, what difference can Biden make? The obvious area is in foreign policy, where the president has the most freedom to act alone. At the top of the list is China. As Tom Mitchell notes in the Financial Times, despite a sense that Trump’s legacy is one of trade wars, the trade representatives of the US and China have in fact managed to “turn trade into what is now arguably the most stable plank in [an] otherwise extremely fraught relationship”. Indeed, adds Mitchell, the China Daily newspaper noted after Biden’s victory that trade is “one of the last threads linking the two sides”. So Biden may simply continue as before – monitoring the results of the “phase one” trade deal which saw China agree to buy more commodities from the US, with a view to progressing to “phase two” next year.

That said, don’t expect relations to improve. For all that Biden is viewed as less volatile than Trump, that doesn’t necessarily mean less tension. Biden will revert to the more multilateral approach used in the past: gathering allies in Europe, North America and Asia to take a joint view under a weaker form of “Pax Americana”. The US will remain wary of China’s expansionism, particularly its growing belligerence towards Taiwan. A return to the “big umbrella” approach may leave China feeling more ganged up on by Western nations than under Trump’s more individualistic approach. As Biden himself put it: “When we join together with our fellow democracies, our strength more than doubles. China can’t afford to ignore more than half the global economy.”

But as Edward Luce notes in the FT, China may also provide Biden with the ideal way to sell investment in big infrastructure projects to his Republican rivals. Luce cites Thomas Wright of the Brookings Institution think tank: “They could find common ground with Republicans on industrial policy, infrastructure and many other areas if they place competition with China at the heart of their agenda.” And a more predictable approach to trade relations may help improve investor sentiment towards emerging markets more generally.

What are the investment implications?

What might all of this mean for your money? As my colleague Matthew Partridge wrote a couple of weeks ago, if Biden does get any kind of “green” stimulus through Congress, then it should be good for renewable energy stocks. That said, as Matthew also noted, the renewables sector has had a good run-up amid the general enthusiasm for all things ESG (environmental, social and governance), with one prominent solar fund up by about 40% in the last three months alone. So ironically, you might be better off looking to the fossil fuel sector as a play on a Biden win. That’s not just our contrarian, value-seeking mentality talking (though it helps). A “green” infrastructure deal might actively help the beaten-down energy sector.

Tighter regulation would not be good news for the fracking industry overall, for example. However, it would come just as low oil prices have already dealt a hammer blow to the sector. Conservation of capital is now the order of the day across the sector, which has already seen a great deal of consolidation. And if pumping out more oil via fracking becomes more difficult, then America’s status as the swing producer – which helps to keep oil prices capped – will be in doubt. In turn, that could send oil prices a lot higher, which would be good news for the more traditional oil companies. Those stocks have already enjoyed a big bounce on the back of the vaccine news but there could be a lot more to come if it turns out that there’s more life in fossil fuels than many now think. Obvious candidates for your portfolio include BP (LSE: BP), Royal Dutch Shell (LSE: RDSA), and Exxon (NYSE: XOM), which remains the most stubbornly committed to oil of all the majors. Or you could bet on US energy stocks as a whole via an ETF – the SPDR S&P US Energy Select Sector UCITS ETF (LSE: SXLE) tracks the big S&P 500-listed US energy companies.

A convenient London-listed option for those who expect more spending on US infrastructure is the iShares Global Infrastructure UCITS ETF (LSE: INFR). Despite the “global” badge, about two-thirds of the ETF is invested in US stocks, with a wide range of investments that cover renewables, telecoms (for all that 5G spending) and railways (if you’re betting on an infrastructure boom you need to get all those materials across the states somehow). If you’re keen to choose individual stocks, Charles Lewis Sizemore in Kiplinger suggests Martin Marietta Materials (NYSE: MLM) which specialises in vital building materials such as concrete, sand, and gravel; and construction equipment giant Caterpillar (NYSE: CAT).

On the healthcare front, Sizemore reckons that health insurer UnitedHealth Group (NYSE: UNH) could be a good bet because it “specialises in Medicare supplemental plans”, which could benefit from any successful expansion of the scheme. A more esoteric option is to bet on further moves towards the legalisation of cannabis in the US, particularly at a federal level. That would make it easier for such businesses to access funding (even when cannabis is legal in individual states, banks are reluctant to fund a business that remains illegal at a federal level). By investing in the Medical Cannabis and Wellness UCITS ETF (LSE: CBDX), UK-based investors can get exposure to a “basket of companies from developed and emerging markets with high exposure to the medical cannabis, hemp and cannabinoids (CBD) industry,” notes the provider, HANetf.

As for stocks to avoid – the banking sector regarded a Biden win with some trepidation due to the scope for higher taxes and more regulation, but neither of those seem as likely now, so we wouldn’t shun financials by any means (particularly if inflation is about to turn). However, the tech sector has been under a lot of scrutiny lately, and that’s only likely to continue as US politicians of all stripes raise concerns about the influence and dominance of the sector. That said, if tech stocks really have reached the end of their present boom cycle, it’ll be due to a more fundamental shift in the interest rate cycle rather than any explicit policies Biden pushes through.

John here – quick note before we start this morning: it’s MoneyWeek’s 20th anniversary and we’ve just released a very special video interview between Merryn Somerset Webb and investor and entrepreneur Jim Mellon, who contributed some extremely lucrative investment ideas to our first issue. Find out what Jim’s buying now and what he expects over the next 20 years by watching the video right here.

Three days on, and the 2020 US presidential election is still a mess. It looks as though Democrat Joe Biden, currently with 253 of the 270 seats he needs to win, has shaded it, though by a much smaller margin than anticipated.

Allegations of electoral fraud abound, however, and Republican Donald Trump has threatened to contest the result in court, though we don’t know what he will do until they finish counting the votes.

The Republicans, however, have held the Senate. That means it will be harder to push through the Democrat agenda. The Democrats, on the other hand, have held onto their majority in the lower chamber, the House, albeit with some key losses. A contested outcome was the outcome everybody feared – and markets have loved it.

Everything’s up – except the US dollar (and uranium)

The Dow’s up, the S&P 500 is up, the Nasdaq is up. Bond prices are up (yields are down). Gold and bitcoin prices are flying, the latter especially – we are now through the $15,000 barrier. Metals prices are up. Even oil was up – West Texas Intermediate went from $34 to $39, a 15% rally on the news.

It’s hard to find anything that’s down. Cameco (TSX:CCO, NYSE:CCJ), the world’s largest listed uranium producer, is about all I could find, suggesting that the uranium price will not like the news. Cameco continued a decline that started in the summer and it’s not hard to see why. Uranium is a highly politicised energy source, and not one that Democrats are known for championing.

Jerome Powell, chair of the Federal Reserve, America’s central bank, added some sauce to the mix yesterday by calling for more economic stimulus and issuing a warning to any Republicans who might stand in the way of this, as they did in the 2009 to 2011 period: “All of us lived through the experience of the years after the global financial crisis. And for a number of years there in the middle of the recovery, fiscal policy was pretty tight, and I just would say that we’ll have a stronger recovery if we can just get at least some more fiscal support.”

The 2 November copy of Barron’s magazine hailed Powell as “The Winner”, and if you want to get an idea of just how hubristic central banking has become, get this quote from yesterday: “Further [economic] support is likely to be needed to avoid further spread of the virus.” I’m hoping that’s a slip and he meant the economic damage caused by the virus, not the virus itself. I wasn’t aware economic support stoped viruses.

What would a Biden presidency mean for investors?

We have in Joe Biden a president who will favour fiscal expansion, even more so than Donald Trump. He has called for more than $4trn in tax increases and over $7.3trn in government spending over the next decade. That means greater spending deficits and a larger national debt.

The bulk of his tax increases will come by raising the top marginal tax rate paid by corporations from 21% to 28%. Perhaps some of the many US corporations that have just relocated onshore will move abroad again. I should send Biden a copy of my book! Higher tax rates do not equal greater government revenue, but that’s an argument for another column. Another target source for Biden’s new tax revenue will be a 12.6% Social Security payroll tax on individuals with annual earnings of more than $400,000. He’s after higher earners.

He will spend the money on infrastructure, education, the social safety net, and healthcare. Infrastructure gets $2.trn, while $1.9trn is slated for education – college and university will be tuition-free for children in families with incomes of less than $125,000. Healthcare and the social safety net both get $1.trn.

The Fed, as we have seen, is on board. Powell is calling for continued aggressive fiscal and monetary stimulus. “The Desk is prepared to increase the size and adjust the composition of its purchase operations as needed to sustain the smooth functioning of the Treasury market,” said Powell. In other words, the money is there to be had.

The big question then, is how much of this can Biden get through Congress? But all in all, we can sum it up by saying something we have said on these pages many times: “money printer go brrr”. The US money printer is going to brrr so loudly, you’re going to need ear plugs. The reverberations will be heard all over the globe. No wonder the US dollar tanked this week. No wonder bitcoin went through $15,000.

Britain and Europe will do exactly the same thing.

Asset prices will rise, and the value of money will fall. Those with assets will make good, those on salaries will suffer. The same trend that has been in place since 1971 continues, and it just got that little bit faster.

You can shout, you can scream, you can rant on Twitter. It won’t make any difference. You can’t change anything. But you can protect yourself. Own gold, own bitcoin, own assets. (If you read my column, you will already). Keep your head down, and enjoy the ride.

Daylight Robbery – How Tax Shaped The Past And Will Change The Future is now out in paperback at Amazon and all good bookstores with the audiobook, read by Dominic, on Audible and elsewhere.