Things are getting a bit hotter for the Federal Reserve regarding the tradeoff between growth and inflation, according to JPMorgan CIO Michael Cembalest. For the last few years, he notes, a zero rate policy was put on autopilot given excess labor and industrial capacity. Both are shrinking now, and when looking at a broad range of variables, some are clearly mid-cycle. If so, in a few months Fed governors will have to jump out of the 0% interest rate pot and remove some of the liquidity that it has infused into the US economy; and, Cembalest warns, despite today's jobs print, they may have to do so at a quicker pace than what markets are pricing in.
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As Cembalest concludes,
To be clear, the Fed might not define things like credit market liquidity and investor risk-taking as factors that should explicitly influence policy rates (although retiring Fed governor Stein has mentioned credit market distortions as something the Fed should be concerned about). But when you combine these factors with the rest of the picture (a recovery in growth, gradually rising inflation and shrinking excess capacity), it is harder to justify the “emergency policy rates” now in place. One thing is for sure: monthly wage and consumer price inflation reports are going to be very closely watched from here on out, adding a source of volatility to US equity markets.
Source: JPMorgan's Michael Cembalest
