Market strategists bluntly state that the Federal Reserve cannot mistake the price increases driven by external energy shocks for overheated economic demand. If policymakers tighten financial conditions to demonstrate their determination against inflation, they may commit a policy error that jeopardizes economic growth.

Written by: Wu Yu, Jin Shi Data

As oil prices edge closer to $100 per barrel again, a market strategist warns that if the Federal Reserve raises interest rates amidst energy price shocks, it may repeat one of the most destructive policy mistakes made prior to the 2008 financial crisis—misjudging the price increases caused by energy supply shocks as economic overheating.

James Thorne, Chief Market Strategist at Wellington Altus, stated on social media platform X on Monday: "Basic economics: You cannot raise interest rates under energy supply shocks!"

He further questioned whether the Federal Reserve, led by Kevin Warsh, would repeat the European Central Bank's mistakes by tightening policy during energy supply shocks, mistaking price increases caused by external factors for overheating demand.

Thorne connects the current situation to 2008. At that time, Federal Reserve Chairman Ben Bernanke warned that rising energy prices "increase the upside risks to inflation and inflation expectations." Thorne believes that the Federal Reserve was overly focused on inflation and inflation expectation risks, while neglecting that high energy prices were eroding household purchasing power and dragging down economic growth.

He stated that investors often remember the Federal Reserve's emergency rate cuts following the collapse of Lehman Brothers but overlook that the Federal Reserve had already begun to consider tightening policy at that time, while the European Central Bank raised rates on the eve of the financial crisis.

Thorne believes that the policy signals being sent by today’s Federal Reserve and European Central Bank bear similarities to the narratives preceding the 2008 crisis, implying that they may further tighten financial conditions and suppress demand under energy shocks to demonstrate their commitment to fighting inflation.

"Will the Federal Reserve learn from past lessons?" Thorne questioned, "We know the European Central Bank did not."

He believes the European Central Bank has already repeated this mistake. The European Central Bank raised rates by 25 basis points to 2.25% in June, becoming the first major central bank to raise rates due to inflation triggered by the Iran war; the market then widely expected it would raise rates again by 25 basis points at the meeting on September 10, with traders giving a 99% probability.

The rise in oil prices provides a real backdrop to these concerns. Over the past month, U.S. WTI crude oil has risen over 20%, and Brent crude has increased more than 18%. U.S. gasoline prices surged to $4.15 per gallon over Labor Day weekend, setting a record for September.

Household Finances Under Pressure, Yet Job Market Remains Resilient

Meanwhile, a survey released by the New York Fed on Tuesday showed that American consumers' perceptions of their own financial situations are deteriorating. In August, 38.6% of respondents believed their household finances had "significantly worsened" or "somewhat worsened" compared to a year ago, up from 37.6% in July; the proportion expecting further deterioration in financial conditions over the next year also rose from 30.3% to 32.6%.

Job market indicators show a split picture. Respondents perceived the probability of unemployment over the next year to drop to 13.8%, the lowest since February; the probability of voluntarily leaving a job increased for the second consecutive month to 19.5%, above the average level over the past 12 months. However, the average probability of expecting an overall rise in the unemployment rate over the next year increased to 44.4%, the highest since April 2020; if they lose their job, respondents felt their probability of finding work within three months dropped to 45%.

Inflation expectations improved slightly. Consumers' expectations for inflation over the next year and five years remain at 3.6% and 3%, respectively, while expectations for the next three years slightly decreased from 3.3% in July to 3.2%.

Previous employment data still showed resilience in the labor market. U.S. non-farm payrolls increased by 162,000 in August, exceeding all expectations in Bloomberg's survey, while the unemployment rate maintained at 4.1%.

The Federal Reserve will hold a policy meeting in Washington on September 15-16, after maintaining interest rates unchanged for five consecutive times. At the last meeting, three officials leaned towards a 25 basis point rate hike, while an increasing number of officials began questioning whether the current interest rate level is sufficient to suppress inflation.

The U.S. Bureau of Labor Statistics will release the August Producer Price Index (PPI) on Thursday and the Consumer Price Index (CPI) on Friday. These two data points will serve as significant references for the Federal Reserve in navigating this policy dilemma.