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Why FOMC Members’ View on Inflation Is Bad for Equity Markets

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Feb. 23 2018, Updated 5:40 p.m. ET

Committee more confident about inflation

The January FOMC meeting minutes indicated that the staff and the members turned bullish on inflation. The confidence of the members about inflation reaching the 2% target over the medium term was evident with the minutes stating that the staff expects core inflation (TIP) growth could be notably faster in 2018. The minutes indicated that almost all the members were of the view that inflation could move up to 2% over the medium term with no major risks to that outlook.

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Expectations for inflation growth

FOMC members have cited several factors that could increase inflation (VTIP) in the medium term. An increase in resource utilization and wage pressures are expected to push prices higher. The recently announced tax cuts, on the other hand, could act as a speed bump to increased inflation (SCHP) if companies decided to pass the profits to consumers through price cuts. The other factor that could help improve inflation was the weaker US dollar (UUP), which would increase the cost of imports, thereby adding to the inflationary pressure.

Outcome of increased inflation expectations

The FOMC staff economic outlook on inflation, if realized, could lead to a higher rate of inflation in the medium term. The US Federal Reserve, at that point, could be forced to change its policy to combat the rise in inflation. The monetary tool available to combat inflation is a rate hike, and this could lead to higher yields, which is negative for bond markets (BND). The resulting bond market pain could spread to other riskier assets like equity markets. In the next part of this series, we’ll discuss the surprise reaction of equity markets to the January FOMC meeting minutes.

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