October 1, 2022

What’s going on: The Fed is expects to raise its key interest rate by three quarters of a percentage point on Wednesday to a range of 3% to 3.25%. But investors see room for even more upside.

They give an 18% probability of a dramatic hike to the full point, a move that would shock markets and reinforce the narrative that the Fed will do whatever it takes to get inflation under control.

Arguments can be given for both options. On the one hand, inflation remains uncomfortably elevated, with consumer prices rising at an annual rate of 8.3% in August. This suggests that borrowing costs may need to rise to reduce demand and prevent further distress.

However, the Fed also knows that it takes some time for past interest rate hikes to feed into the system. And if his playbook is too onerous, it could cause a damaging recession and widespread economic pain, as well as reduce opportunities for future meetings.

“The faster the Fed raises interest rates, the more likely it is to get it wrong,” Gennadiy Goldberg, senior U.S. rates strategist at TD Securities, told me.

There is also a bigger question: can the central bank keep the trust that it will successfully bring inflation down to five, the primary reason for its existence?
Faith in the Fed was shaken by Chairman Jerome Powell’s misguided emphasis that inflation was “transient.” That miscalculation meant the Fed was late in addressing the problem and now has to be more aggressive.

Since then, some credibility has been restored. Bond market expectations for long-term inflation have fallen sharply in recent months, a sign that these investors think the Fed is doing its job.

See: Compare the yield on standard U.S. Treasury bonds with inflation-protected ones. The difference – known as the rate of return – tells you how much inflation investors are predicting.

The five-year yield is 2.48%, down significantly from March’s high of 3.59% and not far from the Fed’s 2% target. The ten-year inflation rate is 2.4%.

“A lot of that has to do with the Fed’s very hawkish tone and their promise to keep rates up until inflation comes back under control,” Goldberg said.

However, he warned that it is too early to “declare that the mission is over”.

“It’s a very weak restoration of that confidence and that faith in the Fed,” Goldberg said. “The difficulty now is that the Fed has to follow through. It’s easy to promise to be hawkish or to be very aggressive in the pace of tightening policy, but you’re really forced to do that tightening at the end of the day.”

Dollar hits new 20-year high as Putin escalates war

The US dollar rose to a a new two-decade high on Wednesday after Russia said it was mobilizing 300,000 military reserves in one the escalation of the war in Ukraine.

The latest: In a televised national address on Wednesday, President Vladimir Putin announced an immediate partial mobilization of Russian citizens and threatened to use “all means at our disposal” to defend Russia “and our people.” He also mentioned the potential use of nuclear weapons.

The speech pushed the greenback up 0.4% against a basket of major currencies to its strongest level since 2002. Investors often look to safe-haven US dollar assets in times of geopolitical tensions.

Oil prices also jumped. Brent crude futures, the global benchmark, rose more than 2% to settle just below $93 a barrel.

The war has increased stress for investors, as it makes it harder to predict when inflation will ease and could force central banks to maintain an aggressive stance for longer.

It also adds to the uncertainty surrounding energy supplies. While gas reserves in Germany are filled to 90% capacity, concerns remain.

Robert Habeck, Germany’s economic affairs minister, said the country could “get through the winter just fine” without Russian gas, but warned of “really empty” supply levels in the period after that.

And costs are rising. Germany nationalized its gas giant Uniper on Wednesday after a rescue attempt failed to prop up the utility.

On the radar: Kremlin-backed authorities in eastern and southern Ukraine have announced they will hold referendums on joining Russia this week. It could mark another key point in the conflict.

The ‘SPAC King’ is losing his crown

Chamath Palihapitiya built its brand by strengthening SPACs, “blank check” companies that go public and then seek takeover targets. Their popularity exploded during the recovery from the pandemic, but they have since fallen out of favor.

Now even the outspoken capitalist is dealing with the consequences.

Palihapitiya announced on Tuesday that it would shut down two SPACs after failing to find firms to merge with. All funds raised will be returned to shareholders.

“Ultimately, getting the deal done would have required us to stretch the price or buy inferior assets — neither things we felt comfortable doing,” Palihapitiya said. He also said he saw “resistance from management teams that were either unwilling or unwilling to face the public markets in the face of current volatility.”

Step back: Palihapitiya was one of the main proponents of SPACs and built a cult following among everyday investors. Still, his approach to investing has taken a hit this year as markets are crowded, a sign of how quickly fortunes on Wall Street have changed.

Stock in Virgin Galactic (SPCE) and SoFi Technologies, previous companies he helped take public, fell 62% and 63%, respectively, in 2022.


General Mills (GIS) reports earnings before US markets open. KB Home (KBH), Lennar (LEN) and Trip.com (TCOM) follow after closing.

Also today:

  • US existing home sales for August at 10:00 AM ET.
  • The Fed releases its latest policy at 2pm ET, followed by a press conference with Chairman Jerome Powell.

Coming tomorrow: the latest policy decisions from the Bank of England, the Bank of Japan and the Swiss National Bank.

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