Market Pulse

Research evidence excerpt

Market Pulse

We're not surprised by the market's sudden turn toward anticipating higher policy interest rates. As we had mentioned

before the employment report, the absence of a wide (negative) output gap and the presence of sticky and high inflation seems

to be calling for higher policy interest rates already, based on the prescribed Fed Funds Rate target under various calibrations

of the Taylor Rule. And, of course, various Fed officials had already turned more hawkish in the remarks and speeches that were

emitting before Friday. (The Fed's quiet period starts today.) We've also highlighted how the US - an oil-exporting economy -

would continue to see high real aggregate income growth throughout the period of high oil prices, all else equal. We've used

this to build a case for the USD staying strong, at least during the period of high oil prices.

Table 1 - US: Estimates of the Prescribed Fed Funds Rate Target from the Taylor Rule, Based on Various

Definitions of the Output Gap and the Natural Rate of Interest (r*)

Source: Atlanta Fed's Taylor Rule Utility

And this morning, at least, high oil prices remain the case. That's because Israel and Iran have exchanged fire since the

weekend. Iran launched a volley of ballistic missiles at Israel during Sunday evening and Monday, after which Israel struck military

targets in western and central Iran. As of this morning, Iran's news agencies report that there were explosions in Tehran, and

that Israel also fired on the Karun petrochemical company in Mahshahr. Of course, the media outlets are not reporting on any

breakthroughs in permanent peace negotiations, nor on any of the main issues still dividing the US and Iran - denuclearization,