Stocks pre-market: The Fed’s credibility is still at stake

What’s happening: The Fed is expected to raise its key interest rate by three-quarters of a basis point on Wednesday, to a range of 3% to 3.25%. But investors see room for even more upside.

They’re putting an 18% chance on a dramatic full-point hike, a move that would surprise markets and reinforce the narrative that the Fed will do whatever it takes to keep inflation under control.

Arguments could be made for both options. On the one hand, inflation continues to rise uncomfortably, as consumer prices increased by 8.3% annually in August. This indicates that borrowing costs may have to rise to reduce demand and face more problems.

However, the Fed knows that it takes some time for past rate hikes to feed through the system. And if its playbook is too harsh, it could cause a damaging recession and widespread economic pain, as well as reduce the chances of future meetings.

“The faster the Fed raises rates, the more likely it is to make a mistake,” Gennadiy Goldberg, chief U.S. rates strategist at TD Securities, told me.

A larger question also looms: Can the central bank maintain the confidence that it will successfully bring about inflation, the very reason for its existence?
The Fed’s faith was shaken by Chairman Jerome Powell’s insistence that inflation was “transient.” That misjudgment meant the Fed was slow to tackle the problem and now needs to be more aggressive.

Since then, some credibility has been restored. Bond market expectations for longer-term inflation have fallen sharply in recent months, a sign that these investors believe the Fed is getting the job done.

Check it out: Compare the yield on standard U.S. Treasury bonds with inflation-protected ones. The difference, known as the break-even rate, tells you how much inflation investors expect.

The five-year default rate is at 2.48%, down significantly from a high of 3.59% in March and not far from the Fed’s 2% target. The 10-year default rate is at 2.4%.

“This has had a lot to do with the Fed’s very hawkish tone and commitment to keeping rates up until inflation is under control,” Goldberg said.

However, he warned that it is too early to “declare the mission accomplished”.

“It’s very tenuous to restore that confidence and that faith in the Fed,” Goldberg said. “The difficulty now is that the Fed has to follow through. It’s easy to promise that it’s going to be hawkish or very aggressive in the pace of policy tightening, but you really have to deliver that tightening at the end of the day.”

Dollar hits new 20-year high as Putin escalates war

The US dollar rose to a new two-decade high on Wednesday after Russia said it was mobilizing 300,000 military reservists in an escalation of the war in Ukraine.

The latest: In a televised national address on Wednesday, President Vladimir Putin announced an immediate partial mobilization of Russian citizens and threatened to use “all means at his disposal” to defend Russia “and our people”. He also mentioned the possible use of nuclear weapons.

The speech pushed the greenback up 0.4% against a basket of major currencies since 2002. Investors often seek the safe haven of US dollar assets during times of geopolitical tension.

Oil prices also rose. Brent crude futures, the global benchmark, gained more than 2% to below $93 a barrel.

The war has increased stress for investors, as it is harder to predict when inflation will ease and could push central banks to maintain an aggressive stance for longer.

Added to this is the uncertainty surrounding the energy supply. Although gas reserves in Germany have been filled to 90% capacity, concerns remain.

German Economy Minister Robert Habeck said the country could “get through the winter just fine” without Russian gas, but warned that supply levels are “really empty” after that.

And the costs are rising. Germany nationalized its gas giant Uniper on Wednesday after a rescue attempt failed to secure the utility’s protection.

On the radar: Kremlin-backed authorities in eastern and southern Ukraine have announced this week that they will hold referendums on joining Russia. This may mark another axis of conflict.

The ‘SPAC King’ loses his crown

Chamath Palihapitiya built his brand by promoting SPACs, which are “blank check” companies that go public and then look for catch-up targets. They exploded in popularity during the recovery from the pandemic, but have since faded away.

Now, even an astute venture capitalist is dealing with the consequences.

Palihapitiya announced on Tuesday that it would dissolve two SPACs after failing to find companies to join them. The money raised will be returned to the shareholders.

“Ultimately, getting a deal would have required us to stretch the price or buy a modest asset, neither of which were things we felt comfortable with,” Palihapitiya said. He also said that he has seen “resistance from management teams who do not want to face the public markets or were not in the face of the volatility.”

Flashback: Palihapitiya was one of the leading proponents of SPACs and created a cult following among everyday investors. However, his approach to investing has taken a hit as markets have taken a beating this year, a sign of how quickly Wall Street’s fortunes have changed.

in stock Virgin Galactic (SPCE) and SoFi Technologies, the previous company that helped take it public, are down 62% and 63% in 2022, respectively.

the next

General Mills (GIS) reports earnings before US markets open. KB Home (KBH), Lennar (LEN) and trip.com (TCOM) continue after closing.

Also today:

  • U.S. home sales for August post at 10:00 a.m. ET.
  • The Fed makes its latest policy announcement at 2pm ET, followed by a press conference with Chairman Jerome Powell.

Coming tomorrow: the latest policy decisions from the Bank of England, the Bank of Japan and the Swiss National Bank.