The Tell: Fed seems to ‘draw a line in the sand’ on inflation, says JPMorgan, as danger of recession exceeds risk of inflation

United States

With central bankers heading to Jackson Hole, Wyo., this week for the Federal Reserve’s most important economic policy event of the year, officials have seemed to “draw a line in the sand” on inflation, as there are reasons to believe that four-decade-high inflation will continue to cool while recession risks are rising, a JPMorgan strategist said in a note Monday. 

According to David Kelly, chief global strategist at JPMorgan Asset Management, the July CPI report, which showed inflation dropping 0.6% from its June peak for a year-over-year rate of 8.5%, offered some hope that inflation is cooling down. Meanwhile, the outlook for August CPI also “looks good,” with a very steady continued decline in gasoline prices, airline fares, hotel rates and used-vehicle prices, which might be enough to generate a second consecutive mild CPI report ahead of the central bank’s policy meeting in September, noted Kelly. 

See: Fed Jackson Hole preview: Powell to stress a recession won’t stop Fed’s fight against high inflation

However, the minutes of the July FOMC meeting showed that Fed officials agreed that it was necessary to move their benchmark interest rate high enough to slow the economy to combat high inflation and then bring it back down to its 2% target. But according to JPMorgan, the danger of recession has already exceeded the risk of inflation, and staying at current levels could inflict long-term economic damage. 

“If the Fed recognizes this in the next few weeks, they will moderate the pace of monetary tightening, potentially giving a further boost to U.S. bond and stock markets,” Kelly said in Monday’s client note. “If they do not, then interest rates could be higher in the short run but probably lower next year. The ultimate destination is likely the same either way — a slow-growing economy with moderate inflation and interest rates.”

“However, the more volatile economic and market cycle that could be unleashed by an overly aggressive Federal Reserve could lead to a further near-term reassessment of valuations that would likely favor value over growth, and, by ultimately sinking the U.S. dollar, favor international over U.S. equities,” according to Kelly. 

See: Beware of a ‘bear trap’ retreat in stocks after the big summer rally, strategists warn

U.S. stocks on Monday recorded the worst trading day in two months as investors worried the Federal Reserve may not pivot away from sharply higher interest rates to fight inflation. The S&P 500 SPX, -2.14% fell 90.49 points, or 2.1%, to finish at 4,137.99. The Dow Jones Industrial Average DJIA, -1.91% was down 643.13, or 1.9%, to 33,063.61, while the Nasdaq Composite COMP, -2.55% declined 323.64, or 2.6%, ending at 12,381.57.

Yields on 10-year Treasury notes TMUBMUSD10Y, 3.019% climbed to 3.035% on Monday to their highest level since July 20, as investors awaited an update from Federal Reserve Chairman Jerome Powell, who is expected to deliver a highly anticipated speech on the economic outlook later in the week. The yield on the 2-year Treasury  TMUBMUSD02Y, 3.301% rose to 3.335%, its highest since June 14. Yields move in the opposite direction of prices.