The US Fed held rates steady but flagged more tightening ahead. And markets finally caught on that the central bank is deadly serious about taming inflation.

So are we entering a new era of ‘higher for longer’ interest rates? As Greg Canavan and I mentioned before, when consensus forms in markets, it pays to listen to your inner contrarian. Rising bond yields suggest investors are more confident inflation can return to target without a sharp slowdown. But how confident should investors really be?

As Milton Friedman once said, it takes time for inflation to be cured and unpleasant side effects of the cure are unavoidable. What’s not priced in? The extent of those side effects.

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Title: What’s Not Priced in EP18: The Fed is About to Be Blindsided

Introduction:
The Federal Reserve (Fed) plays a crucial role in the United States’ economy, setting policies and making decisions that impact interest rates, job growth, inflation, and financial stability. However, despite the Fed’s influence, there are instances where it fails to consider certain factors that could significantly affect its decisions. In the case of EP18, the Fed is about to be blindsided by overlooked variables that may lead to unforeseen consequences for the economy.

EP18 and Its Implications:
EP18 refers to the 18th episode of an ongoing economic phenomenon that reflects the Fed’s inability to fully comprehend external circumstances. It often occurs when the central bank fails to give adequate weight to factors that exist beyond mainstream economic indicators. These neglected variables can encompass anything from social dynamics and technological disruptions to geopolitical uncertainties.

Blind Spots in the Fed’s Analysis:
1. Socio-political Factors:
One of the most prominent aspects the Fed frequently overlooks is the interplay between social issues and economic outcomes. Factors such as income inequality, racial diversity, and social unrest have tangible economic effects, including decreased consumer spending, political instability, and reduced investor confidence. Ignoring these social dynamics can lead to a false understanding of the true state of the economy.

2. Technological Disruptions:
Rapid advancements in technology also quickly become disruptive forces within the economy. However, the Fed often struggles to keep pace with the transformative nature of these advancements. Neglecting these changes can result in misplaced economic policies, missed opportunities for growth, and challenges in adapting to a shifting labor market.

3. Geopolitical Risks:
The Fed’s focus on domestic economics often blinds it to international issues that can significantly impact the economy. Geopolitical risks, such as trade tensions, political unrest in other countries, or the influence of global superpowers, can send shockwaves throughout financial markets. Failing to price in these risks can lead to miscalculations regarding interest rates, foreign exchange rates, and even stock market fluctuations.

4. Environmental Impact:
As the effects of climate change intensify, environmental risks are increasingly impacting financial markets. Extreme weather events, water scarcity, or policy shifts towards sustainability can have profound economic implications. Failing to consider these factors can derail growth, impact investment decisions, and disrupt entire sectors, leaving the Fed unprepared to respond effectively.

Consequences and Future Considerations:
Neglecting these blind spots can result in grave consequences for both the economy and the Fed’s credibility. The underestimation of such factors can lead to policy errors, asset bubbles, and economic instability. Recognizing the importance of these variables and integrating them into the Fed’s analysis would allow for more informed and comprehensive decision-making, minimizing the risk of being blindsided.

To address these issues, the Fed should establish robust communication channels with various stakeholders, including academics, technologists, social scientists, and environmental experts. Engaging in multidisciplinary collaborations and research can help the Fed anticipate and navigate potential blind spots more effectively, ensuring that all relevant factors are priced into their policy decisions.

Conclusion:
EP18 serves as a reminder that the Federal Reserve must expand its understanding of economic dynamics and broaden its perspectives to avoid being blindsided by unforeseen circumstances. By incorporating socio-political, technological, geopolitical, and environmental factors into its analysis, the Fed can better serve the economy, maintain stability, and make informed decisions that shape a sustainable and resilient future for all.