Currently, we have signs of both a slowing economy and inflation rates starting to come down. So it seems odd that central bankers still remain committed to interest rate hikes.

Add in the fact that monetary policy tends to lag by anywhere from six to twelve months, and it’s clear that the Fed could overtighten before realizing it. So why are bankers still committed to hiking rates? It may have to do with expectations.

Central bankers play a powerful role in how people view the economy. If the Fed were to cheer a slight drop in inflation rates, investors may view inflation as no longer a problem. That could lead to the economy remaining stronger for longer, keeping inflation higher.

Right now, the Fed is looking to get inflation back from over 8 percent today to 2 percent. That’s a process that could take some time. But it will go faster with a little bit of economic pain.

For the Fed, that pain point tends to be the job market. Nothing cuts back spending faster than job losses. Even those who don’t lose their jobs may cut back on spending out of fear that they’re next.

With a robust labor market right now, the Fed’s recent calls for more tightening make sense. And that’s why investors should continue to expect interest rates to move higher.

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Asset prices are based on a number of variables. There are metrics like the price-to-earnings ratio in the stock market. Or the level of an interest rate when looking to get a home mortgage.

But prices can also be influenced by emotions. Investors didn’t seem to mind when stimulus checks hit the economy, as it led to higher asset prices right away. Now, we’re dealing with the inflationary after-effect of printing so much mone

A number of investors have already noted the amount of money increasingly being created and moving into the financial system over the years. That’s led to a few calling all asset classes as overpriced, even in a “superbubble.” And if market sentiment changes, that could lead to a huge drop.

One such proponent is Jeremy Grantham, who sees a reckoning coming. With both stocks and bonds down a sizeable amount this year, other asset prices may decline as well. And as long as the Federal Reserve is willing to raise interest rates, there will continue to be pressure on financial assets like stocks and bonds.

As financial assets drop, the big winner from the inflation and money printing of the last few years appears to be the lower 50 percent of households. They’ve seen job changes and bigger salaries and raises, which may lead them better off in real terms.

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In a complex global economy, actions can lead to any number of unexpected reactions. Some of those consequences are known in advance. Others are not. And how market participants react to them can lead to even more unknown and unexpected reactions.

The past few years has seen a massive growth in big economic changes. The global pandemic shut down large parts of the economy, but some sectors ended up thriving.

For example, the housing market seemed like a likely candidate for a painful drop in prices and a slow recovery as people stayed at home. Instead, the decline in interest rates and a desire to move out of densely-populated areas fueled a boom.

And with many workers able to continue with remote work, stimulus payments to keep the economy open may have ended up overstimulating the economy. That may have caused most of the inflation that’s going on now.

We are still dealing with an abnormally strong job market, while also dealing with supply chain issues. And new legislation to contend with semiconductor chip manufacturing and green energy projects are already leading to changes that could result in further reverberations.

The point is, every action can have an unintended consequence. Those who think ahead to the full effect and position themselves accordingly can end up investing in the right place at the proverbial right time.

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For years, investors have followed a rule: Don’t fight the Fed. The central bank of the US determines monetary policy. And they tend to announce their plans months in advance to avoid anything that may lead to a financial panic.

Last week, the Fed came out and noted that more pain would be ahead in a move to curb inflation. That reversed the market that had been trending higher since the June lows.

The Fed is making it clear that they’re not about to change their policy of raising interest rates anytime soon. If anything, comments from multiple Fed members in the past week make it sound like tighter financial conditions are necessary.

The Fed has plans to bring inflation back down to a range of 2 percent. From today’s rate over 8 percent, much more tightening will be needed.

It’s even possible that a recession will be inevitable. The Fed is trying to avoid that scenario, which they call a “hard landing.” But with extreme inflation underway, and tough talk now, traders need to seriously look at the prospect for a further drop in the markets in the weeks ahead.

Investors should still brace for even higher interest rates in the months ahead, and for the rate-hike policy to continue. That suggests moving to cash now, as stocks and bonds may fall further. That risks losing out to inflation, but if inflation is declining, it may be the best move to make now.

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