TRADING DAY-Whisper it ... but is this the top?

By Jamie McGeever

ORLANDO, Florida, Sept 25 (Reuters) - TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist

World stocks posted their biggest fall in more than three weeks and the dollar rose on Thursday, as surprisingly strong U.S. growth figures cast doubt on how aggressive the Federal Reserve's interest rate-cutting cycle will be.

In my column today I look at the reasons why the Fed may one day consider replacing its current 2% inflation target with an inflation range. Atlanta Fed President Raphael Bostic likes the idea. Will other Fed officials be so keen?

If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.

1. How a U.S. government shutdown could affect financial markets

2. Global investors, blindsided by stunning U.S. comeback, jump back in

3. Artificial Intelligencer: Why Microsoft passed on Stargate

4. 'ChatGPT, what stocks should I buy?' AI fuels boom in robo-advisory market

5. Global debt hits record of nearly $338 trillion, says IIF
   
   
   

Today's Key Market Moves

• STOCKS: Wall Street in the red, small-cap Russell 2000 underperforms. Argentina -4%.

• SHARES/SECTORS: Energy the only S&P 500 sector in the green, +0.9%. Biggest gainers are Intel and IBM, while CarMax -20%, Oracle and Freeport-McMoRan slump.

• FX: Dollar rises, posts biggest two-day rise in two months, up against nearly every currency in the world. In G10 FX biggest losers are NOK followed by GBP, SEK, NZD.

• BONDS: U.S. yields rise broadly, as much as 6 bps at the short end to bear flatten the curve. 7-year auction isn't greatly received.

• COMMODITIES: Copper down after Wednesday's spike, oil steadies. Non-gold precious metals rally - silver, platinum, palladium up 3-4%.

Today's Talking Points:

* Back and froth

Investors calling the bursting of the AI/tech bubble and the equity market top in recent months have been burned badly. And often. So why should this current wobble be any different?

There may be no obvious reason or catalyst. The risks are well-known by now - stretched valuations, positioning, concentration, and faith in AI's productivity-enhancing powers. And the Fed is cutting rates now, so that's more fuel for the rally, right? Perhaps. Or perhaps it marks the contrarian top.

* Crypto blues

After rebounding some 65% from its April lows, bitcoin seems to have hit a ceiling. The world's biggest cryptocurrency has mostly flatlined over the last three months, a period in which it has reached its record high around $124,000.

Its underperformance against gold, tech and stocks more broadly is beginning to deepen, especially in the last month - down 7% in that period versus gold's 11% rise. Rising Treasury yields are putting fiat dollar in a more attractive light too.

* Debt ceiling? What debt ceiling?

Global debt stands at a record high of $337.7 trillion, an Institute of International Finance report showed on Thursday, driven by easing global financial conditions, a weaker dollar and accommodative policy from major central banks. Global debt has risen $21 trillion in the first half of the year.

These are big numbers, but should we be worried? It's something to keep an eye on, of course, but as world growth and activity rises so should borrowing. And as a share of GDP, debt actually fell again, to a five-year low. Also, one man's debt is another man's asset, right?

Fed could abandon 'illusion of precision' with inflation range

There's little prospect of the Federal Reserve changing its 2% inflation target right now. But the composition of the Fed's board is changing and Jerome Powell's term as Fed Chair expires in May, so could discussions about an alternative to the fixed 2% target soon begin to percolate?

Figures on Friday are expected to show that U.S. inflation in August exceeded the Fed's 2% goal for the 54th month in a row. Even accounting for all the shocks of recent years and inbuilt flexibility in the Fed's post-COVID inflation framework, that's a long time for a central bank to miss its target.

And there's every likelihood that inflation won't get back to 2% for several more months, probably years. Fed officials' median projections don't expect headline or core PCE inflation to get back to 2% until 2028.

Even that timeline could prove to be tough. The Fed has a dual mandate, and rising risks to the employment side of it have prompted the central bank to resume its interest rate-cutting cycle. But financial conditions are the loosest in years and growth is still humming along at a decent clip, so rate cuts now could stoke price pressures further.

The Fed failing to meet its inflation target is hardly new. But the longer inflation stays above target, the more likely it is that credibility in the target and the Fed's policymaking more broadly could erode.

That may encourage the Fed to rethink the target altogether.

'ILLUSION OF PRECISION'

Changing a target that's been missed every month for over four years - essentially moving the goal posts - is certainly not a good look.

That said, trial balloons are best floated early, and one potential alternative to the current target is an inflation range, which some Fed officials have nodded to recently, most notably Atlanta Fed President Raphael Bostic.

In an interview with George Mason University senior research fellow David Beckworth on the Macro Musings podcast this week, Bostic said he would be open to a range in the future.

"Sometimes there's this illusion of precision, that we can move inflation to the third decimal place. I don't really think that's real," Bostic said.

"In today's environment, we're at 2.4 (percent), 2.6, 2.8, somewhere in that range, and people are asking, is that 2 (percent)? For me? No, my range would be narrower, but it's a good conversation to have," he said, adding that 1.75% to 2.25% would be a good start.

An inflation range carries the obvious advantage of providing policymakers with more flexibility than a specific point. It would give the Fed more license to have inflation above 2% while technically being in breach of its stated goal.

The wider the range, the greater the leeway, although on the flip side, inflation momentum could build up rapidly if left unchecked, forcing uncomfortably aggressive policy responses.

'VAGUER AND LONGER'

While ranges are most prevalent in emerging markets where economic volatility is usually high, they are also used by monetary authorities in advanced economies like Canada, Australia and New Zealand.

Central banks still appear to prefer more precise inflation targets rather than ranges. At least that was the conclusion the Bank for International Settlements came to in a recent study of 26 central banks that had implemented some form of inflation targeting since 1990. However, the BIS also found that the time horizon allowed to meet these more rigid targets has gotten "vaguer and longer" over time.

The latter part of that would certainly apply to the Fed - four and a half years and counting. And if Fed officials think it might take another three years to right the ship, consumers are even more pessimistic.

The latest University of Michigan survey of consumers shows one-year inflation expectations at 4.8% and five-year expectations at 3.9%. These may be on the high side given the apparent fragility of the labor market, but the Fed still won't be happy to see figures this elevated, as unanchored inflation expectations can lead to a wage-price spiral.

In economics, gradual change is usually preferred, at least by markets. So rather than making an abrupt move to a higher inflation target down the line, adopting an inflation range – which the Fed essentially already has – may be something more officials will join Atlanta Fed President Bostic in considering.

What could move markets tomorrow?

• Japan Tokyo CPI inflation (September)

• Canada GDP (Q2, prelim)

• U.S. PCE inflation (August)

• U.S. University of Michigan consumer sentiment (September, final)

• Federal Reserve officials scheduled to speak include Vice Chair for Supervision Michelle Bowman and Richmond Fed President Thomas Barkin
  

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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.