US interest rate could be raised to 9.25% if soft landing not possible: SocGen

Neither the author, Tim Fries, nor this website, The Tokenist, provides financial advice. Please review our website policy before making any financial decisions.

The Federal Reserve is trying to stamp out inflation without pushing the economy into recession, but the effort is akin to drawing blood from a stone. While everyone agrees that this task is extremely difficult, a think tank from Societe Generale proposed a bipolar policy in which a soft landing could be achieved if rate hikes slowed.

The Fed has two choices in the fight against inflation

The research team at one of France’s oldest banks argues for a two-pronged approach, led by Societe Generale Quant Research director Solomon Tadesse. The Fed will either have to opt for a growth-centric or inflation-centric approach:

  • The stifling of inflation would stifle the equity market to some extent, as it is accustomed to the cheap cost of capital. This would result in a total interest rate hike of 9.25% and a balance sheet reduction of $3.9 trillion as QT.
  • Alternatively, a growth-oriented policy would result in a half-measure, like a soft landing.
Image credit: Societe Generale Quant Research

In other words, the Fed operates within this cost-benefit spectrum. The Fed must choose the gravity of the landing so that few wheels fall. One of these wheels is the employment rate if monetary policy leads to a recession.

The Fed’s Hot Potato Juggling

The very reason the Fed more than doubled its balance sheet was to avoid the stock market crash during the C19 event. In turn, the central bank imposed a tax in the form of inflation. That was the long-term cost of that decision.

Inflation rose after the Fed more than doubled the money supply. Image credit:

Although inflation cannot be called a tax, it acts as such, imposing a general increase in the cost of living. Now that this “tax” is becoming politically problematic, a reversal of the balance sheet is necessary. Specifically, the reduction of Treasury securities as public debt.

From March 2020 to May 2022, the Fed’s securities portfolio grew from $3.9 trillion to $8.5 trillion. Image credit:

By buying up Treasury securities, as well as mortgage-backed securities (MBS), at a monthly cap of $60 billion, the Fed can gradually reduce its bloated balance sheet. This quantitative tightening (QT) will slowly intensify by the end of 2022.

The Fed’s security buyback roadmap. Image credit:

In turn, just as quantitative easing (QE) drove interest rates down due to Fed money flooding the banks, quantitative tightening (QT) drove interest rates higher. After all, the banking system is then emptied of excess money, thus undoing QE.

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Inflation-hedge assets decline as macro conditions remain uncertain

To illustrate further, the monetary spectrum between QE and QT is equal to heating or cooling the economy. Inflation is a clear manifestation that the economy is overheating, inflating the stock market over the past two years as the Fed got it hooked on cheap borrowing.

The soft landing then cools the economy without pulling the grass underfoot too harshly. Last Thursday, Fed Chairman Jerome Powell admitted that it would be quite difficult.

“So a soft landing is really getting back to 2% inflation while maintaining a strong labor market…Whether we can execute a soft landing or not may actually depend on factors that we let’s not control.”

Jerome Powell in a interview in the marketplace

During her European tour, US Treasury Secretary Janet Yellen clarified on Wednesday that some of these uncontrollable factors are global food and energy price hikes following the conflict between Ukraine and the Russia. These can trigger the worst-case scenario: stagflationa cooling economy with high unemployment and inflation.

For now, assets considered growth-oriented are the hardest hit. Specifically, the tech-heavy Nasdaq index and bitcoin.

Amid the Fed-induced portfolio reshuffle, investors prefer the S&P 500 index. Image credit: commercial view

Interestingly, the so-called inflation hedges – gold, silver, bitcoin – perform best, in hopes that the Fed will manage to keep inflation under control.

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Elon Musk recently said that the United States would likely find itself in a prolonged recession. Do you think market signals need to be corrected by a recession to avoid stagflation?

About the Author

Tim Fries is the co-founder of The Tokenist. He has a B.Sc. in Mechanical Engineering from the University of Michigan and an MBA from the University of Chicago Booth School of Business. Tim was a senior partner on the investment team in the US Private Equity division of RW Baird and is also a co-founder of Protective Technologies Capital, an investment firm specializing in detection, protection and control solutions.

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