January's consumer-price index report, issued late last week, estimated a rise of 7.5% from a year ago, the fastest rate of increase since 1982.

As market researcher Jim Bianco noted on Twitter, that isn't just an economic problem. It is a political one — especially in an election year:

Half the country thinks their standard of living is going to fall because of inflation, as explained here. This puts the Fed in an impossible position.

  • Help the half that sees inflation hurting them by aggressively hiking rates.
  • Help those with incomes > $100K by not hiking aggressively in order to prop up stock prices.

The Fed has to pick one or the other but cannot help both groups with one policy.

Bianco, and many others, think the Fed will side with Main Street, not Wall Street.

For years, the Federal Reserve has ridden to the rescue whenever the stock market began to totter. We saw it most recently in early 2020 when the COVID panic began to take hold. The Fed unleashed significant firepower, in the form of bond-buying, rate-cutting, relaxing regulatory requirements, and more. The market rebounded — with gusto.

Since the Financial Crisis in 2008-2009, the market has become used to the Fed watching its back. But in 2022, things are different. Inflation is rearing its head for the first time in 40 years.

This morning on CNBC, St. Louis Federal Reserve President James Bullard, a voting member of the Fed's policy-setting arm, described inflation as "broadening and possibly accelerating." Echoing comments he made late last week, he said significant rate hikes are needed to tame inflation — and he put a number and time frame on that: increases totaling around 1% between now and July 1.

Repricing rate hikes

Of course, we won't know for sure what the Fed does until it does it. Still, it appears market observers and participants are increasingly convinced the Fed is serious about making inflation-fighting its top priority. From Bloomberg:

The specter of [rising inflation] drove money markets to price in a full percentage point of rate increases through July, the equivalent of a traditional quarter-point move at each of [the Fed's] next four meetings, and slightly more than six such moves in 2022. Treasuries fell sharply, driving the policy-sensitive two-year note’s yield up as much as 15 basis points to about 1.51%, the highest since January 2020, and the 10-year yield breached 2%, a level not seen since 2019.

And from Barron's:

As traders scrambled to reprice rate hikes, so did Wall Street economists. Goldman Sachs changed its rate projection to seven from five quarter-point increases this year, and three next. Deutsche Bank now similarly sees 1.75% by year end, starting with a half-point increase.

The chart below shows the anticipated (but not yet official) rate hikes for the next 12 months. (As recently as December, market traders were predicting only two hikes this year.) 

More than economics

Undoubtedly, many of the predictions about rates and timing will turn out to be wrong, at least in "precise" terms. But rates will rise — perhaps with aggressive increases on the front end. What that will mean for stocks remains fuzzy, but it is almost certain that the Fed will consider propping up the market as less critical than reining-in inflation — at least for a while.

Part of the reason is economic — inflation is tough to tame when it gets out of hand. You can't let it go on too long before taking action. But, as noted above, another part of the reason is political.

To be sure, inflation is an "equal opportunity destroyer," as the saying goes. Even so, it is far easier for people with financial means to keep up with inflation by investing in things that grow with inflation. In contrast, people who are toward the middle-to-lower end of the economic spectrum are less able to keep up. In addition, they already spend a higher proportion of their income on the necessities of life (food, shelter, energy), and those necessities are costing more and more.

Policy responses to COVID have been especially harmful to many people in this "non-investor class." Now, inflation is starting to take its toll, too. Suppose the Fed were to side with "the stock market" at a time like this (whether that's a fair characterization or not). Doing so could further destabilize an already shaky cultural situation. 

Time will tell what the Fed will do and when. But the market has recently become convinced the Fed means business about tackling inflation.