The Fed’s “Instability Trap”: What if the Fed can’t hike rates?

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Assessment: Unfortunately, we doubt the Fed has the stomach for “financial instability.” As such, we doubt they will hike rates as much as the market currently expects …

What if the Fed can’t hike rates? It’s an interesting question and one we delved into in Part 1 – “Fed Won’t Hike Rates As Much As Expected.”

With the January FOMC meeting now behind us, we have much better visibility about the Fed’s intentions.

The road to hell is paved with good intentions.”

While the Fed may intend to hike rates and taper their balance sheet, the real question is, “can they?”

The Fed’s Inflation Trap

There are two primary considerations for the Fed as we progress into 2022. As noted in part-1, the reversal of liquidity is problematic.

As recently discussed, “deflation” is the overarching threat longer-term. However, in the short term, the flood of liquidity into the system created, as expected, surging inflationary pressures. With the measure of money in the system, known as M2, skyrocketing, the resulting surge in inflation is not surprising.

“And I heard a voice in the midst of the four living creatures saying, “A quart of wheat for a denarius, and three quarts of barley for a denarius; and do not harm the oil and the wine.” Rev. 6:6

Furthermore, in a previous Bloomberg interview, (Democrat) Larry Summers stated:

Larry Summers sends inflation warning to White House: Dominant risk to economy is 'overheating' - CNNPolitics

“There is a chance that macroeconomic stimulus on a scale closer to World War II levels will set off inflationary pressures of a kind not seen in a generation. I worry that containing an inflationary outbreak without triggering a recession could be even more difficult now than in the past.”

As we indicated in part-1, inflation surged almost exactly 9-months after the massive infusions of fiscal policy. So while many, including the Fed, suggest inflation is problematic, M2 indicates disinflation remains the most likely outcome.

The current surge in inflationary pressures pushed the Fed to hike rates and reduce its bond-buying program. However, they could be acting precisely at the wrong time. In 1998, Alan Greenspan started aggressively hiking rates to combat an “inflation threat” that never materialized. The resulting consequence was the implosion of the “dot.com” bubble.

However, such is why inflation isn’t the most significant risk limiting the Fed.

The Fed “Instability” Trap

“When it comes to Federal Reserve policy, investors are focused on the wrong question. Investors continue to agonize over when the Fed will trim its $120 billion in monthly asset purchases. A more important question is when will the Fed raise interest rates. More important still: whether the Fed actually can raise rates.” – Joe LaVorgna, Barron’s

That is a critical question. As discussed previously, the Fed is dependent on “stability” to keep the financial “house of cards” from collapsing.

Read More @ Zero Hedge HERE

With the entirety of the financial ecosystem heavily dependent on debt, the “instability of stability” is the most significant risk to the Fed.