Welcome to my latest video presentation. For a transcript that condenses my remarks, read the article below.

Congressional gridlock precludes significant fiscal measures to fight inflation. We’re dependent on the Federal Reserve and monetary policy to strike the right balance between sustaining employment and keeping a lid on prices.

Although Fed Chair Jerome Powell has put aside the word “transitory” to describe inflation, Powell and his cohorts continue to suggest that it’s a short-term problem caused by supply chain imbalances. That said, last week the Fed announced faster tapering and the probability of three policy rate hikes in 2022. Hotter-than-expected inflation data prompted contractionary steps from the U.S. central bank.

The crisis that justified massive monetary stimulus has largely passed, so it’s only logical that the Fed should wind down its balance sheet. The pandemic has eased from its worst days in 2020, despite the emergence of the Omicron variant, and the economy is back on its feet. The hawkish pivot already is priced into equities.

However, shifting monetary policy is generating volatility. As we head into 2022, this uneasiness will be the new normal.

The stock market initially greeted the Fed’s hawkish moves last week with a relief rally. Accelerated tapering hardly came as a surprise, and it actually reassured investors that the Fed wasn’t being complacent about inflation.

But as investors digested the reality of rate hikes next year, the mood soured and stocks tumbled (see table).

Inflation is heating up, but let’s keep our sense of perspective. The economy has bounced back to pre-pandemic levels of gross domestic product (GDP) at a record pace.

The 10-year Treasury rate is below 1.5%, the lowest it’s been in advance of Fed tightening. Since 1985, 10-year rates averaged 5.3% at the time of the first Fed rate hike.

Meanwhile, the size of the Fed’s balance-sheet assets as a percentage of GDP hovers at the highest level since World War II. With the jobs market on the mend and wages rising, the bigger danger to the economy and financial markets would be if the Fed were caught flat-footed fighting inflation.

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The Fed is now on a path to finish its bond purchase program in Q1 2022. Instead of killing the bull market, accelerated tapering is likely to herald a prolonged period of turbulent trading. Huge amounts of liquidity will no longer shore up the market when it confronts new challenges.

It’s not just the Federal Reserve; foreign central banks are emphasizing the fight against inflation over Omicron.

Last week, the Bank of England and the European Central Bank took actions similar to those of the U.S. Federal Reserve. Central bankers are running out of justification for ultra-dovish monetary policy, as economies improve and inflation worsens.

When 2022 gets underway, investors will be fixated on the rate-hike cycle, with stocks spiking up or down depending on signals from the Fed. The rally is likely to continue, as economic growth and corporate earnings remain robust, but brace yourself for a bumpy ride, akin to the choppiness we witnessed last week.

Consider the heightened volatility during previous rate-hike cycles. For example, in the six months before the initial Fed rate hike in December 2015, average daily market volatility, as measured by the CBOE Volatility Index (VIX) jumped 20% compared with the preceding six-month timeframe.

The Fed’s greater hawkishness is boosting the U.S. dollar. When interest rates rise, it tends to make the greenback stronger. The higher yields attract investment capital from investors abroad seeking higher returns on bonds and interest-rate products.

The dollar’s rise underscores how investors view the strengthening U.S. economy as a more desirable alternative compared to other national economies.

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Editor’s Note: The topic of inflation tends to stir impassioned debate. If you’d like to weigh in with your comments or questions concerning Fed policy and inflation, contact me at: mailbag@investingdaily.com. To subscribe to my video channel, follow this link.