Tomorrow’s Federal Reserve meeting might be the single most critical event in determining the future of the economy. Here’s a breakdown of why it’s so important (and why you should care).
2021 was a year of crazy growth. The economy boomed and everything went up, from stocks to crypto. Economic boom? Sounds great! Unless… we take it too far and the economy overheats.An overheating economy is an economy that is expanding at a rate that is unsustainable in the long term. There are various flags for an overheating. The main one: high inflation.
As you all know, we have been witnessing dangerously high inflation rates in the past few months. The Fed is now faced with a critical decision: increase interest rates or keep them largely the same.
On Wednesday, Fed Chair Powell is expected to signal to the markets which way the Fed is leaning. This decision will be the fork between two entirely different futures:
1. Do not raise interest rates.
The engine keeps running and keeps overheating. More record highs for the S&P, stocks keep ballooning, asset prices keep going up… And inflation keeps ripping: bread more expensive, gas more expensive, cars more expensive, everything more expensive! End of 2022: “Remember when $100 used to be worth something?”
2. Raise interest rates.
Raising interest rates is an effective way to slow the economy down. The problem: it will deepen this dip and probably cause a recession. Here’s why:
Let’s use a car engine analogy. When you’re going at top speed, there’s a chance that your car engine overheats. A good driver will press the brakes well before the engine overheats and balance between throttle and brakes to keep going at high speed, without overheating. If the driver screws up and the engine does overheat, just hitting the brakes won’t do it: they will need to stop the car. Stop the car = stop the economy (or severely slow it down) = recession.
Economists often talk about a “soft landing”. It means a slow down of the economy, without a crash. A soft landing is easier when inflation is controlled.
Historically, a soft landing has been impossible once inflation has gone crazy (ie. once an overheating already happened). In short, if Powell signals that a series of aggressive interest rate hikes is coming, a recession becomes likely. End of 2022: “I guess all bubbles have to burst at some point.”
Kalshi’s markets are pricing a rate hike by March at 25%. It will be very interesting to see how this changes after Wednesday’s press conference. https://kalshi.com/markets/FED-015