Elon Musk warns that a major Fed rate hike could cause a major economic crisis

Tesla CEO Elon Musk has warned that a major rate hike by the Federal Reserve could cause deflation in the US economy. Musk’s warning follows an analysis by Cathie Wood, CEO of Ark Invest, who warned that “leading inflation indicators such as gold and copper signal the risk of deflation.

Elon Musk, Fed rate hikes and deflation

Tesla and Spacex CEO Elon Musk tweeted Friday night that “A significant Fed rate hike risks triggering deflation“. His tweet got a lot of attention. As of this writing, it has been liked 80,000 times and retweeted nearly 7,000 times.

Comments poured in, with some agreeing with the Tesla CEO while others insisted he was wrong about the US economy. Raoul Pal, CEO of Real Vision and cryptocurrency investor, agreed with Musk, tweeting: “Yup. It’s rather baked in the cake.

Northmantrader founder and chief market strategist Sven Henrich pointed out that the danger is that the Federal Reserve is “obtuse to the consequences.” He clarified that the central bank was “too slow to react in the first place” and that she “now step on the brakes“, emphasizing that the Fed is “too dependent on retrospective data and risks breaking everything quickly.

Peter Schiff offered a different view, responding to Musk:

It risks hyperinflation. The rising cost of servicing debt, a severe recession, exploding federal budget deficits and collapsing asset prices will produce a financial crisis worse than that of 2008. The Fed will respond with massive quantitative easing, which which will cause the dollar to fall and consumer prices to skyrocket.

Politicians also took part in the conversation. US Congresswoman Nancy Mace said: “If Joe Biden and Nancy Pelosi hadn’t spent trillions of dollars that we don’t have, we wouldn’t be having this conversation…

Federal Reserve Chairman Jerome Powell recently underscored the central bank’s hawkish stance during his speech in Jackson Hole. He noted that the Fed’s fight against inflation “will cause some pain“. Many people are concerned about the Federal Reserve raising interest rates, including US Senator Elizabeth Warren, who said she was “very worried” that central bank action would tip the US economy into recession.

Musk’s tweet follows a to analyse by Cathie Wood, CEO of Ark Invest, who warned of deflation on Wednesday. “The Fed bases its monetary policy decisions on lagging indicators: employment and core inflation,” she explained, specifying:

Leading inflation indicators like gold and copper signal the risk of deflation. Even the price of oil has fallen more than 35% from its peak, erasing most of the gains made this year.

One of the best gauges of inflation, the price of gold peaked over two years ago in August 2020 at $2,075 and fell around 15%. Timber prices fell over 60%, copper -30%, iron ore -60%, DRAMs -46% and crude oil -35%“, explained Cathie Wood.

Further downstream, retailers appear to be swimming in inventory that they may be forced to aggressively reduce in order to free up shelves for merchandise. The surprise could be the deflation of the CPI and the PCE deflator by the end of the year“, added the leader. “In the pipeline, inflation turns into deflation“.

Elon Musk said in August that inflation has peaked and “will fall rapidly.” He also predicted that we will probably have a recession of about 18 months.

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