Morgan Stanley says the odds of a 20% stock market correction will depend on how much 3rd-quarter earnings growth decelerates

Wall Street and New York Stock Exchange in Downtown Manhattan, New York City, USA
  • The odds of a 20% correction in the S&P 500 will depend on how much third-quarter earnings growth will decelerate, Morgan Stanley said.
  • “We are gaining confidence in a sharper deceleration but the timing is more uncertain,” strategists said.
  • The benchmark index has thus far corrected by 6% before staging a bit of a recent rebound.
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The odds of a correction of up to 20% in the S&P 500 will depend on how much third-quarter earnings growth decelerates or declines, Morgan Stanley said in a note this week.

“We are gaining confidence in a sharper deceleration but the timing is more uncertain,” strategists led by Michael Wilson wrote in a note to clients.

The downside scenario is a path the strategists in September dubbed “Ice,” which would occur if upward earnings revisions slow and higher-frequency macro datapoints deteriorate. The upside scenario they called “Fire,” and is a more optimistic outlook that would occur if the Federal Reserve begins to pull back on accommodative policies as the US economy heats up.

The market embarked down the fire path following the Fed’s announcement that it will finally tighten monetary policy. Now, they are waiting for the timing and magnitude of Ice, which will determine when the mid-cycle transition will be over, they said.

“Our Fire and Ice thesis is playing out,” they said. “Decelerating growth is normal during the mid-cycle transition for both the economy and earnings. However, this time the deceleration in growth may be greater than normal.”

The S&P 500 has been volatile and choppy in recent weeks as it catches up to rotations and rolling corrections, the strategists said, adding that this was expected.

“The S&P 500’s more erratic behavior since the beginning of September has coincided with the Fed’s more aggressive pivot toward tapering of asset purchases,” they said. “While the average stock has already experienced a 10-20% correction this year, the S&P 500 has avoided it, at least so far.”

The S&P has seen a correction of about 6% from recent highs, the analysts noted.

“As of today, that de-rating is about halfway done based on prior mid-cycle transitions,” the strategists said. “Whether this correction is 10%, 20%, or already over will be determined by what happens to earnings revisions over the next few months.”

Screen shot of Morgan STanley research - "Fire" and a 20% P/E Contraction Is the Typical Ending to the Mid-Cycle Transition
“Fire” and a 20% P/E contraction is the typical ending to the mid-cycle transition

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Treasury Secretary Janet Yellen said minting a trillion-dollar coin would be a ‘gimmick’ that ‘jeopardizes the independence of the Federal Reserve’

Treasury Secretary Janet Yellen next to a mockup of a coin
Treasury Secretary Janet Yellen said she did not support minting a trillion-dollar coin.

  • Treasury Secretary Janet Yellen on Sunday said she opposed minting a trillion-dollar coin.
  • Doing so would be a last-ditch effort at avoiding an economic disaster if US lawmakers failed to raise the debt ceiling.
  • But Yellen called the move a “gimmick” and said it could politicize the Federal Reserve.

Treasury Secretary Janet Yellen on Sunday doubled down on her opposition to minting a $1 trillion coin as a last-ditch solution to avoid the US defaulting on its debts.

“I wouldn’t be supportive of the trillion-dollar coin. I think it’s a gimmick. I think it jeopardizes the independence of the Federal Reserve,” Yellen said Sunday during an appearance on ABC News’ “This Week.”

“You would be asking to essentially print money to cover the deficit,” Yellen told ABC News’ George Stephanopoulos. “This is a shared bipartisan responsibility.”

She noted the debt ceiling had been raised nearly 70 times since 1965 “almost always on a bipartisan basis.”

“No one party is responsible for the need to do this. I believe it should be a shared responsibility, not the responsibility of any one party,” she said.

Yellen’s comments Sunday echo her previous comments about minting a trillion-dollar coin, which would help the US cover its debts and avoid an economic recession but would undermine faith in US institutions and bring the Federal Reserve into a partisan battle.

As Insider previously reported, the Senate on Thursday narrowly approved a measure that raised the debt ceiling through the beginning of December, preventing a default on the US’ debt for now. The measure, which heads to the House for a vote next week, received no Republican support in the Senate.

Senate Minority Leader Mitch McConnell, a Republican from Kentucky, and 11 other Republicans, however, sided with Democrats in the Senate to break a filibuster opposing the measure to allow lawmakers to come to a vote.

McConnell and his GOP colleagues have been staunchly opposed to raising the debt ceiling, even though refusing to do so would cause the US to default on its debt, sending the country into economic turmoil. The temporary extension Thursday raised the debt limit by $480 billion.

While Republicans have been opposed to raising the debt ceiling, doing so would help pay for debts incurred under the administrations of former President Donald Trump and President Joe Biden, including their pandemic relief programs.

Some Republicans have opposed raising the debt ceiling because it could help finance Democrats’ $3.5 trillion social spending package, arguing instead that Democrats should use party-line reconciliation to raise the limit. McConnell has made it clear that that’s what he expects to happen in December.

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The SEC is taking a hard line on stablecoins right now – but it could permit more coin issuers if it gets to regulate them, a financial policy expert says

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SEC Chair, Gary Gensler.

  • The range of stablecoin issuers could widen if the SEC becomes regulator, despite its tough stance on the cryptos.
  • A fight is brewing between the SEC and the Federal Reserve over which will oversee stablecoins, a senior Cowen analyst said.
  • If the Fed wins, big banks will have an advantage in stablecoin issuance, Jaret Seiberg said in a note.
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The Securities and Exchange Commission is taking a hard line on stablecoins right now – but if it ends up regulating the asset-backed cryptocurrencies, that could mean a far greater range of these coins on offer.

That’s the view of Jaret Seiberg, a DC-based financial services policy analyst at Cowen, who noted the government agency has a tough rival for the oversight role.

“We see a fight brewing between the Federal Reserve and SEC over which will regulate stablecoins,” Seiberg said in a note this week.

The boom in crypto assets’ popularity over the past year has regulators training their sights on potential risks to investors and to the financial system.

Gary Gensler, chairman of the SEC, has likened stablecoins to “poker chips” at the casino in the “Wild West” crypto market. Stablecoins are cryptocurrencies backed by fiat money such as the US dollar, or by traditional assets with stable value.

Tether and Circle, the two biggest stablecoins by market capitalization, have taken regulatory heat recently, with the SEC issuing an investigative subpoena to Circle this summer.

Gensler and Fed Chair Jerome Powell were among top officials – including Treasury Secretary Janet Yellen – who hinted at tightening the rules around stablecoins when they met to discuss tether in July.

The SEC boss has said some stablecoins may well be securities. Meanwhile, the Fed chief has said stablecoins are like money market funds, or bank deposits.

If the SEC wins the fight for oversight, it would treat stablecoins like prime money market mutual funds, or MMMFs, which come with liquidity requirements and redemption limits, according to Cowen.

“We believe there will be a greater diversity of stable coin issuers if the SEC prevails. Many entities from asset managers, to banks to securities firms could be issuers,” Seiberg said.

The Fed will take a bank-regulatory approach, according to Cowen. Stablecoins would become another deposit product, with the usual bank rules and Community Reinvestment Act obligations.

“If the Federal Reserve wins this fight, then we expect big banks to have the advantage when it comes to stable coin issuance,” Seiberg said.

The Biden administration appears to support the Fed’s approach, as it has been pushing Congress to create a bank-like charter for stablecoins. It has urged the Financial Stability Oversight Council to look into stablecoin-related risks to the financial system.

Cowen expects the FSOC to deem stablecoins “systemically important,” paving the way for the Fed to oversee them like banks. The central bank has a key ally in Yellen, a former Fed boss who now chairs the FSOC.

“This is not the first power struggle between the two. They fought in the 1990s to be the umbrella regulator of financial firms. The Fed won that battle,” Seiberg said.

Cowen believes the SEC has the edge because the markets regulator is seen as having the simplest path to bringing in a regulatory regime.

“The FSOC process has been cumbersome, and Congress rarely acts,” Seiberg said about the Fed’s path.

By contrast, the SEC may be able to treat stablecoins as securities, clearing the way for rules like those for money market mutual funds.

Whichever way it goes, there’s little real difference for stablecoins between the two regulatory regimes, according to Cowen. Either would boost confidence.

“To us, both options should reassure investors that stablecoins are fully backed by US dollars. That should limit the risk of a run,” Seiberg said

Read More: These 20 stocks are set to grow earnings by at least 20% in 2022, Goldman Sachs says – even as broader market growth slows and taxes rise

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Jerome Powell’s chances of another Fed term are slipping amid stock-trading controversies, betting markets show

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Fed Chair Jerome Powell is due to speak on Thursday.

Jerome Powell’s chances of being confirmed by the Senate as Fed chairman for another term in 2022 are slipping, according to data from betting-markets website PredictIt.

Powell’s chances have fallen from about 80% in August to 61% as of Monday morning. The sharp decline comes amid an ongoing stock trading controversy that has ensnared several Fed governors and led to the resignations of Boston Fed President Eric Rosengren and Dallas Fed President Robert Kaplan.

Annual financial disclosure forms found several Fed governors, including Powell, owned assets that the Federal Reserve was also buying as part of its COVID-19 stimulus program, including municipal bonds and treasuries.

On Friday, Bloomberg reported that Fed Governor Richard Clarida sold between $1 million and $5 million of bonds and used the proceeds to purchase stocks just one day before Powell issued a statement indicating a potential Fed policy change amid the beginning of COVID-19 pandemic last February.

The pressure on Powell mounted last week, with Senator Elizabeth Warren calling the Fed Chairman “a dangerous man” when it comes to his policies towards banks.

“Your record gives me grave concern. You have acted to make our banking system less safe, and that makes you a dangerous man to head up the Fed,” Warren told Powell, adding that she will oppose his renomination.

Another Fed governor, Lael Brainard, is a favorite among progressives to succeed Powell. Her chances of becoming the next Fed Chair have surged on PredictIt to 24% from single digits in the past month.

Regardless, the uncertainty is sure to remain as investors look to sort out who will be next chair, Fundstrat’s Tom Lee said in a Monday note. “Markets don’t like uncertainty, so this will hang over markets for the next few months,” Lee said.

Powell’s term as Fed chair ends in February 2022, while his term as a Fed governor ends in January 2028.

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US futures point to stock market rebound after biggest drop since May, but global energy crunch fans fears of inflation

A trader blows out a chewing gum bubble while working on the floor of the New York Stock Exchange
US stocks fell sharply on Tuesday.

  • US futures climbed on Wednesday after stocks fell the most since May the previous day.
  • Rising bond yields helped send stocks tumbling on Tuesday as investors’ worries mounted.
  • A global energy crunch, the US debt ceiling and China’s Evergrande crisis are all causing concern.
  • See more stories on Insider’s business page.

US stock futures rose on Wednesday, pointing to a rebound at the open after equities suffered their biggest fall since May the previous day.

However, a global energy crunch kept investors on edge about inflation and central bank policy, and the US debt ceiling and China’s Evergrande also caused concerns.

S&P 500 futures were up 0.65% after the index tumbled 2.04% a day earlier. Dow Jones futures were 0.52% higher and Nasdaq 100 futures had risen 0.84%.

In Asia overnight, stocks followed the US example and fell across the board. China’s CSI 300 index fell 1.02% while Tokyo’s Nikkei 225 dropped 2.12%.

European stocks dropped on Tuesday, but rebounded on Wednesday. The continent-wide Stoxx 600 was 0.78% higher, while London’s FTSE 100 rose 0.77%.

A number of factors combined to send global equities tumbling on Tuesday, most importantly a sharp rise in global bond yields, which makes the returns on stocks look less attractive.

The yield on the 10-year US Treasury note rose to 1.534%, its highest since late June, on Tuesday after the Federal Reserve signaled that it may start to cut back on its support for the economy as early as November.

In the UK, the yield on the 10-year gilt rose past 1% for the first time since March 2020 after the Bank of England also said it could tighten monetary policy sooner than expected. Yields move inversely to prices.

Adding to the pressure on Tuesday was a sharp rise in global energy costs. The global benchmark oil price topped $80 a barrel for the first time in three years, helping push up bond yields, as traders bet inflation would be stronger and central banks could be forced to act.

On Wednesday, both oil prices and bond yields slipped after the previous day’s big rises. The yield on the key 10-year US Treasury note fell 2.5 basis points to 1.512%.

Brent crude oil, the global benchmark, fell 0.74% to $77.77, having pared its gains after topping $80 a barrel on Tuesday. WTI crude, the US benchmark, slipped 0.86% to $74.66.

However, natural gas prices remained at record highs in Europe and elevated in China and the US. Higher energy prices have added to investors’ fears about inflation.

“Given ongoing supply chain disruption in a range of sectors, labour shortages and higher commodity and energy prices, we expect to see at least some of these higher input costs being passed through to consumers,” said Chris Scicluna, head of research at Daiwa Capital Markets.

Another concern for investors is the US debt-ceiling crisis. The Republicans have blocked Democratic attempts to raise the government borrowing limit, heightening the risk that the US could default. Wrangling will continue on Capitol Hill on Wednesday.

In China, embattled property developer Evergrande faced another coupon payment on Wednesday for a dollar bond. Reuters reported bondholders were still in the dark about whether they would receive their money.

Elsewhere, bitcoin rose 1.2% to $42,287 after falling the previous two days as investors avoided risky assets.

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The Senate’s banking committee chief will introduce legislation to ban Fed officials from owning individual stocks

Sherrod Brown
Senator Sherrod Brown.

  • Senate Banking Committee Chairman Sherrod Brown wants to ban Fed officials from owning individual stocks.
  • Brown reportedly said Tuesday he’ll introduce legislation to get work on the ban underway.
  • Fed Presidents Eric Rosengren and Robert Kaplan are stepping down following stock controversies.
  • See more stories on Insider’s business page.

Sen. Sherrod Brown, chairman of the Senate Banking Committee, said Tuesday he will introduce legislation to ban officials working at the Federal Reserve from owning individual stocks, after controversial equity holdings by two of the central bank’s regional presidents came to light.

Brown, a Democrat from Ohio, told Federal Reserve Chairman Jerome Powell of his plan during Powell’s appearance at a hearing held by the bank committee on Tuesday, according to Reuters.

Boston Fed President Eric Rosengren and Dallas Fed President Robert Kaplan in recent weeks have been under fire for stock purchases during the pandemic, with critics raising questions about conflict of interest because of their roles in shaping US monetary policy. On Monday, they said in separate statements they would step down from their positions.

At a Fed meeting last week, Powell said that “no one [at the Fed] is happy” about the situation and announced a fresh review of the ethics rules surrounding stock trades.

Kaplan made million-dollar trades in stocks of companies including Tesla and Amazon, according to a disclosure form provided by his bank that was first reported by The Wall Street Journal. Rosengren reportedly actively traded real estate investment trusts. Kaplan and Rosengren earlier this month apologized and dumped their purchases.

Kaplan said he will leave on Oct. 8 and addressed the controversy in a statement from the Dallas Fed.

“The Federal Reserve is approaching a critical point in our economic recovery as it deliberates the future path of monetary policy. Unfortunately, the recent focus on my financial disclosure risks becoming a distraction to the Federal Reserve’s execution of that vital work,” Kaplan said.

Rosengren said he would resign effective Thursday, citing health issues. Rosengren, whose term would’ve been up in June 2022, revealed he has a kidney condition and needs dialysis.

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The Fed presidents who faced calls to resign over their controversial stock trading during the pandemic are stepping down

FILE PHOTO: The Federal Reserve Bank of Boston's President and CEO Eric S. Rosengren speaks in New York, April 17, 2013. REUTERS/Keith Bedford/File Photo
Boston Fed President Eric Rosengren.

  • Boston Fed President Eric Rosengren and Dallas Fed president Robert Kaplan are stepping down.
  • Both had been criticized for investments during the pandemic in firms including Apple, Alibaba, and Tesla.
  • Last week, Fed Chair Jerome Powell announced a fresh review of the ethics rules surrounding stock trades.
  • See more stories on Insider’s business page.

Boston Federal Reserve President Eric Rosengren said on Monday that he is resigning several months early due to health issues, following recent controversy over his stock purchases.

On Monday afternoon, Dallas Fed President Robert Kaplan announced that he would also be resigning in October, citing the “distraction” of his own much-criticized stock trades.

In a letter to Fed Chair Jerome Powell, Rosengren said he would step down effective Thursday to focus on his health.

“While working on the pandemic relief programs for money market mutual funds and small businesses, given the long hours and stress, regrettably my kidney function declined significantly to the point that I qualified for the kidney transplant list,” he wrote.

Rosengren, who is 64, said that preparations had been underway for his retirement next year, as Fed presidents are age-limited at 65 in most cases.

His letter did not mention the stock-trading scandal that has roiled the Fed in recent weeks, sparked by disclosures that Rosengren and Dallas Fed President Robert Kaplan had purchased stock in several big-name firms including Apple, Alibaba, and Tesla. That prompted calls by activists and former Fed officials for Rosengren and Kaplan to step down or be fired.

In particular, Rosengren also made active trades in real estate investment trusts, raising eyebrows about past comments he has made about risks to real estate markets.

At a Fed meeting last week, Powell said that “no one [at the Fed] is happy” about the situation and announced a fresh review of the ethics rules surrounding stock trades.

“We understand very well that the trust of the American people is essential for us to effectively carry out our mission, and that’s why I directed the Fed to begin a comprehensive review of the ethics rules around permissible financial holdings and activity by Fed officials,” said Powell.

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Fed risks tapering surprise, stock market shock as central bank’s inflation forecast not ‘credible’, says Wharton’s Jeremy Siegel

Jeremy Siegel, Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania in Philadelphia, on an interview on December 30, 2014.
Jeremy Siegel, professor of finance at the Wharton School of the University of Pennsylvania.

Wharton finance professor Jeremy Siegel said he does not think the Federal Reserve’s inflation outlook is “credible,” and believes the central bank risks scaling back its monetary policy sooner than expected.

This, he told CNBC Friday, will shock the stock market in early 2022.

“I look at these inflation forecasts that the Fed put, I don’t find them credible at all,” he said, referring to the central bank’s 4.2% target this year and its 2.2% target next year. “We’re going to have much more inflation.”

He continued: “When you see worse inflation, the Fed is going to be pressured and that’s going to disturb the market and that’s down the line.”

Siegel added the US economy can expect “a couple more” bad consumer price index reports towards the end of the year. But in the next two months, he said “the road looks clear” since the Fed will be continuing with its program.

“Powell opened the door saying, if things get worse, we will have to taper faster,’ Siegel told CNBC. “If that happens toward the end of the year, that would rattle the market.”

Siegel also called on the central bank to be more aggressive in containing inflation. He did note that there is not much the Fed can do when it comes to controlling rising prices. Attempting to do so, he noted, will “trouble” the market and the economy.

“I worry actually about an overreaction. Because a lot of that inflation that we’re going to have, I think it’s already there in the pipeline,” Siegel told CNBC. “The Fed can’t really do anything about it.”

The outlook from the Federal Open Market Committee meeting that concluded on Wednesday indicated that tapering asset purchases may “soon be warranted.” Half of the Fed officials expect the first rate hike to arrive by next year.

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Morgan Stanley’s Dennis Lynch says bitcoin’s ability to recover is like the character Kenny from South Park that ‘dies every episode’

South Park and death
South Park and death

  • Morgan Stanley’s Dennis Lynch compares bitcoin’s ability to bounce back to the character Kenny from South Park.
  • Lynch, who heads up an asset management subsidiary of the bank, said bitcoin is “anti-fragile”.
  • He said people will look at bitcoin as “digital gold”, or even as a currency in its own right, given the low-rate environment.
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Bitcoin’s ability to bounce back from even the deepest sell-off is like South Park character Kenny’s comical ability to return to life after dying in each episode of the long-running cartoon series, according to Morgan Stanley’s Dennis Lynch.

Lynch, who heads up Morgan Stanley asset management subsidiary Counterpoint, was discussing bitcoin at Morningstar’s annual investment conference on Thursday.

“I like to say that bitcoin’s kind of like Kenny from South Park – he dies every episode, and is back again,” he said.

Bitcoin’s extreme volatility means it’s just as capable of rallying 10% in a day as it is of falling 10%. It’s seen a number of sell-offs this year, most recently at the start of this week, when it dropped by almost 9% in a day on Monday to its lowest in six weeks, as part of a broader market decline on the back of concerns about indebted Chinese property firm Evergrande.

But it’s since risen by about 14%, more than recouping those losses. In fact, bitcoin has fallen by 10% or more on a single day on at least six occasions this year, and every time, it’s bounced back.

Like Kenny of the Comedy Central franchise, bitcoin just keeps coming back, Lynch said.

“I think (bitcoin) demonstrates some ‘anti-fragile’ qualities during this period of time – anti-fragile being something that gains from disorder,” he said.

“It kind of sits in the portfolio in a small manner, that it is something that can go right when the rest of our portfolios have something going wrong,” he said.

Part of the boom in cryptocurrency demand this year has stemmed from ultra-low interest rates that have depressed the dollar and driven investors into riskier, higher-yielding assets.

“I can envision (bitcoin) benefiting from different environments, whether people look at it as a digital gold, or people start to really question (the) fiat currency, given all the stimulus and the policy there – (since) the Fed has had to be so accommodating,” Lynch said.

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Americans were freaking out over inflation this spring. They aren’t anymore – and it shows they believe in the Biden economy.

Two masked women walk along S. Catalina Avenue in the Riviera Village shopping area of Redondo Beach, CA.
Riviera Village shopping area of Redondo Beach, CA.

  • Google searches for “inflation” have plummeted close to pre-crisis levels, Bespoke Investment Group said Thursday.
  • The slide suggests Americans buy President Biden’s argument that surging price growth is temporary.
  • The easing concerns could help Biden’s outlook materialize, as inflation is guided by Americans’ expectations.
  • See more stories on Insider’s business page.

Inflation still sits at decade highs, but Americans are less and less worried about it.

Just four months after inflation fears peaked, public interest in nationwide price growth sits near pre-crisis lows. Google searches for inflation and inflation-related terms plummeted through the summer and are now roughly one-third the levels seen in May, according to data collected by Bespoke Investment Group. Search activity is now the lowest it’s been since fall 2020 and below some peaks seen before the pandemic.

The months-long decline in inflation searches suggest a newfound confidence in the economic recovery.

For President Joe Biden and the Federal Reserve, the trends were expected. Both said earlier in the year that quick reopening would boost inflation, particularly in sectors where activity completely froze during lockdowns. Instead of cutting stimulus and putting the administration’s infrastructure plan on ice, Biden pushed for both. Inflation, the administration argued, would fade even with more government spending.

Source: Bespoke Investment Group

And inflation did pick up. Price growth rocketed to its fastest pace since the Great Recession. Republicans seized on the public’s concerns, linking inflation to Democrats’ $1.9 trillion stimulus plan. And all the while, Americans concerns over surging prices leaped higher.

That phenomenon has since abated, and the return to normal levels of concern reflects the public is confident in the Biden administration and the Fed’s outlooks.

Where Republicans amplified concerns of irresponsible spending and an inflation crisis, the White House sees recent price growth as a side effect of the otherwise healthy recovery. Americans are increasingly siding with the latter, according to search trends.

That suggests Democrats have public support as they work to finalize Biden’s next spending package. Moderate Senate Democrats have balked at its $3.5 trillion price tag, with Sen. Joe Manchin saying in a Wall Street Journal column that the party should “pause” to see if inflation “is transitory or not” before spending more. Americans seem to be telling Manchin they don’t need a pause.

Recent inflation reports have also fallen in line with Biden’s forecast. Price growth slowed sharply for a second straight month in August as categories that previously saw rapid inflation cooled off. While year-over-year inflation remains elevated, monthly price growth is on the decline.

The slowdown could be aided by Americans’ easing worries. Inflation is somewhat driven by people’s expectations, and fears of permanently soaring prices can speed up inflation. The data, then, signals Americans could be helping the government’s inflation dreams come true.

“If this more recent trend of declining search interest continues, it would further support the Fed’s forecast for recent inflation pressures to be ‘transitory’ in nature,” Bespoke said in a Thursday blog post.

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