Why this iconic investor believes bigger rate hikes could ‘restore’ the market, not ruin it

As the world frets over oversized interest rate hikes, one high-profile fund manager thinks such a move would be good for share markets.

The comment from Pershing Square founder Bill Ackman stands at odds with investor sentiment. The fear is that large rate hikes will tip the US economy into a recession, which will drag on ASX shares.

But Ackman is calling on the US Federal Reserve to lift rates by 100 basis points (bps) “tomorrow, in July and thereafter”, as reported by Bloomberg.

Are bigger rate hikes better?

The call is larger than the 50bps to 75bps increase that most economists are expecting as the Fed struggles to get on top of runaway inflation.

But, in Ackman’s opinion, the 100-point spike to the Fed Funds Rate will help restore market confidence. He said the central bank had allowed inflation “to get out of control” and called for “aggressive action” that would help restore market confidence.

The hope is that the ongoing hike risk that’s rocking share markets, including the ASX, can be more quickly passed through the system. It’s akin to ripping off the Band-Aid as quickly as possible to get the pain over with.

A crisis in confidence

Certainly, confidence is a commodity in short supply at the moment. Several market experts have voiced similar concerns to Ackman that the Fed has lost credibility given its inflation forecasts have been consistently wrong.

The thinking is only aggressive hikes will help the Fed get on top of inflation and show the market it’s serious about controlling the risk.

But as interest rates are an imprecise mechanism to control inflation, there is likely to be collateral damage to the wider economy.

Recession red flags on aggressive rate hikes

As it stands, Wall Street’s favourite recession indicator is flashing red. The bond yield curve has inverted where the short-term US government bond yield is higher than its longer-term counterparts.

Why investors are spooked is because such inversions have preceded every US recession in the past 60 years.

RBA tainted by the same brush

But it isn’t only the US Fed being criticised for being behind the eight ball when it comes to rate hikes. Several experts in Australia have levelled similar accusations at the Reserve Bank of Australia (RBA).

This could put additional pressure on the RBA to adopt an even tougher interest rate stance as some experts accuse it of being too slow to respond to surging inflation.

The new federal Labor government has promised to undertake a review of the RBA. Several prominent economists are urging it to appoint independent overseas experts for the task.

Given how rare such reviews are for the venerable institution, this is a space ASX investors should be paying close attention to.

The post Why this iconic investor believes bigger rate hikes could ‘restore’ the market, not ruin it appeared first on The Motley Fool Australia.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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