Why Wall Street Is Cheering the Federal Reserve’s War on Inflation

  • The Federal Reserve hiked interest rates a half-point on May 4 and the initial reaction was jubilation.
  • Profit-taking overnight meant markets opened down on May 5.
  • The aim of the Federal Reserve’s action is to pop bubbles like those in tech without damaging the real economy.
A photo of the outside of the Federal Reserve Building.

Source: MDart10 via shutterstock.com

Wall Street wanted strong action to tame inflation. That’s what the Federal Open Market Committee delivered, unanimously. Its press release stated it “anticipates that ongoing increases in the target range will be appropriate.” That means more rate hikes are coming. In a separate release, the Federal Reserve said it will start reducing the size of its balance sheet on June 1.

The government will initially sell $30 billion of Treasury securities and $17.5 billion of agency securities each month. It will double that starting in September. This will cut the money supply.

If the economy has been overheating, the brakes are being applied.

The Banker’s Federal Reserve

Fed chairman Jerome Powell, who was initially appointed to the board by President Obama, made chairman by President Trump and was re-nominated last year by President Biden, has an unusual background for his role.

Powell is a lawyer and banker, not an economist. He has worked at law firms, banks and even ran a private equity firm. He has won confidence from both parties for pragmatism, and from Wall Street for supporting rising markets.

Confidence in Powell extends around the world. Asian stocks rose overnight, even as China reported its Purchasing Managers Index fell to 36.2, indicating economic contraction is underway.

Powell is acting to tame commodity inflation that is on its fastest pace since 1982. Prices rose at a 6.6% annual rate in March, meaning inflation-adjusted income declined. The Fed must navigate between rising prices and the possibility of recession. Powell believes it can do that. “With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong,” the statement said.

Tech Whips Inflation Now

Unlike in 1982, the Fed has a big ally in this inflation fight. It comes in the form of technology, which has proven its ability to drop costs and keep growth going for 40 years.

Companies like Amazon (NASDAQ:AMZN) can now break bulk and deliver goods to consumers’ doors for no more than it costs Walmart (NYSE:WMT) to stock shelves. Cloud data centers have made working from home practical for millions, and cloud applications have automated corporate operations. Solar panels and wind turbines have put a thumb down on energy prices, and agriculture operations are moving closer to cities.

All these gains must be balanced against the costs of climate change, the war in Ukraine and a decade of declining investment in fossil fuels. While the Federal Reserve can control U.S. interest rates and the money supply in the short term, its control over global supply chains is limited.

Because so much of the technology industry is based in the U.S., along with half the world’s cloud data centers, the Fed has room to maneuver. The Dollar Index, measuring our currency’s value against those of other currencies, has been rising for a year. It hasn’t been this high, and with an upward trajectory, since 1999.

That means a dollar buys nearly 130 yen, the Euro’s value is down to $1.06, and the British pound is worth just $1.24. This lowers the cost of imports, reducing our inflation, but increases the cost of exports, which can widen the trade deficit.

The Bottom Line

Powell has a strong hand in the current inflation fight. The Fed’s actions will make the American hand in global finance even stronger.

Technology has made the U.S. economy the strongest it has been, relative to the world, since the late 1990s. That may be the biggest danger Powell faces, because excess cash has been creating bubbles in housing, stocks and cryptocurrencies.

The aim of the Fed’s action is to pop those bubbles without damaging the real economy. There is no certainty here, but the tech bubble has already popped, and Wall Street is betting its banker can get the others, too.

On the date of publication, Dana Blankenhorn held a long position in AMZN. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, available at the Amazon Kindle store. Write him at danablankenhorn@gmail.com, tweet him at @danablankenhorn, or subscribe to his Substack.

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