ORLANDO, Florida (Reuters) -TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist 

World stocks posted their biggest fall in more than three weeks and the dollar rose on Thursday, as surprisingly strong U.S. growth figures cast doubt on how aggressive the Federal Reserve's interest rate-cutting cycle will be.

In my column today I look at the reasons why the Fed may one day consider replacing its current 2% inflation target with an inflation range. Atlanta Fed President Raphael Bostic likes the idea. Will other Fed officials be so keen?

If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.

1. How a U.S. government shutdown could affect financialmarkets 2. Global investors, blindsided by stunning U.S. comeback,jump back in 3. Artificial Intelligencer: Why Microsoft passed onStargate 4. 'ChatGPT, what stocks should I buy?' AI fuels boom inrobo-advisory market 5. Global debt hits record of nearly $338 trillion, saysIIFToday's Key Market Moves

* STOCKS: Wall Street in the red, small-cap Russell 2000underperforms. Argentina -4%. * SHARES/SECTORS: Energy the only S&P 500 sector in thegreen, +0.9%. Biggest gainers are Intel and IBM, while CarMax-20%, Oracle and Freeport-McMoRan slump. * FX: Dollar rises, posts biggest two-day rise in twomonths, up against nearly every currency in the world. In G10 FXbiggest losers are NOK followed by GBP, SEK, NZD. * BONDS: U.S. yields rise broadly, as much as 6 bps at theshort end to bear flatten the curve. 7-year auction isn'tgreatly received. * COMMODITIES: Copper down after Wednesday's spike, oilsteadies. Non-gold precious metals rally - silver, platinum,palladium up 3-4%.Today's Talking Points:

* Back and froth

Investors calling the bursting of the AI/tech bubble and the equity market top in recent months have been burned badly. And often. So why should this current wobble be any different?

There may be no obvious reason or catalyst. The risks are well-known by now - stretched valuations, positioning, concentration, and faith in AI's productivity-enhancing powers. And the Fed is cutting rates now, so that's more fuel for the rally, right? Perhaps. Or perhaps it marks the contrarian top.

* Crypto blues

After rebounding some 65% from its April lows, bitcoin seems to have hit a ceiling. The world's biggest cryptocurrency has mostly flatlined over the last three months, a period in which it has reached its record high around $124,000.

Its underperformance against gold, tech and stocks more broadly is beginning to deepen, especially in the last month - down 7% in that period versus gold's 11% rise. Rising Treasury yields are putting fiat dollar in a more attractive light too.

* Debt ceiling? What debt ceiling?

Global debt stands at a record high of $337.7 trillion, an Institute of International Finance report showed on Thursday, driven by easing global financial conditions, a weaker dollar and accommodative policy from major central banks. Global debt has risen $21 trillion in the first half of the year.

These are big numbers, but should we be worried? It's something to keep an eye on, of course, but as world growth and activity rises so should borrowing. And as a share of GDP, debt actually fell again, to a five-year low. Also, one man's debt is another man's asset, right?

Fed could abandon 'illusion of precision' with inflation range

There's little prospect of the Federal Reserve changing its 2% inflation target right now. But the composition of the Fed's board is changing and Jerome Powell's term as Fed Chair expires in May, so could discussions about an alternative to the fixed 2% target soon begin to percolate?

Figures on Friday are expected to show that U.S. inflationin August exceeded the Fed's 2% goal for the 54th month in arow. Even accounting for all the shocks of recent years andinbuilt flexibility in the Fed's post-COVID inflation framework,that's a long time for a central bank to miss its target.

And there's every likelihood that inflation won't get backto 2% for several more months, probably years. Fed officials'median projections don't expect headline or core PCE inflationto get back to 2% until 2028.

Even that timeline could prove to be tough. The Fed has adual mandate, and rising risks to the employment side of it haveprompted the central bank to resume its interest rate-cuttingcycle. But financial conditions are the loosest in years andgrowth is still humming along at a decent clip, so rate cuts nowcould stoke price pressures further.

The Fed failing to meet its inflation target is hardly new.But the longer inflation stays above target, the more likely itis that credibility in the target and the Fed's policymakingmore broadly could erode.

That may encourage the Fed to rethink the target altogether.

'ILLUSION OF PRECISION'

Changing a target that's been missed every month for overfour years - essentially moving the goal posts - is certainlynot a good look.

That said, trial balloons are best floated early, and onepotential alternative to the current target is an inflationrange, which some Fed officials have nodded to recently, mostnotably Atlanta Fed President Raphael Bostic.

In an interview with George Mason University senior researchfellow David Beckworth on the Macro Musings podcast this week,Bostic said he would be open to a range in the future.

"Sometimes there's this illusion of precision, that we canmove inflation to the third decimal place. I don't really thinkthat's real," Bostic said.

"In today's environment, we're at 2.4 (percent), 2.6, 2.8,somewhere in that range, and people are asking, is that 2(percent)? For me? No, my range would be narrower, but it's agood conversation to have," he said, adding that 1.75% to 2.25%would be a good start.

An inflation range carries the obvious advantage ofproviding policymakers with more flexibility than a specificpoint. It would give the Fed more license to have inflationabove 2% while technically being in breach of its stated goal.

The wider the range, the greater the leeway, although on theflip side, inflation momentum could build up rapidly if leftunchecked, forcing uncomfortably aggressive policy responses.

'VAGUER AND LONGER'

While ranges are most prevalent in emerging markets whereeconomic volatility is usually high, they are also used bymonetary authorities in advanced economies like Canada,Australia and New Zealand.

Central banks still appear to prefer more precise inflationtargets rather than ranges. At least that was the conclusion theBank for International Settlements came to in a recent study of26 central banks that had implemented some form of inflationtargeting since 1990. However, the BIS also found that the timehorizon allowed to meet these more rigid targets has gotten"vaguer and longer" over time.

The latter part of that would certainly apply to the Fed -four and a half years and counting. And if Fed officials thinkit might take another three years to right the ship, consumersare even more pessimistic.

The latest University of Michigan survey of consumers showsone-year inflation expectations at 4.8% and five-yearexpectations at 3.9%. These may be on the high side given theapparent fragility of the labor market, but the Fed still won'tbe happy to see figures this elevated, as unanchored inflationexpectations can lead to a wage-price spiral.

In economics, gradual change is usually preferred, at leastby markets. So rather than making an abrupt move to a higherinflation target down the line, adopting an inflation range -which the Fed essentially already has - may be something moreofficials will join Atlanta Fed President Bostic in considering.

What could move markets tomorrow?

* Japan Tokyo CPI inflation (September) * Canada GDP (Q2, prelim) * U.S. PCE inflation (August) * U.S. University of Michigan consumer sentiment (September,final) * Federal Reserve officials scheduled to speak include ViceChair for Supervision Michelle Bowman and Richmond Fed PresidentThomas BarkinWant to receive Trading Day in your inbox every weekday morning? Sign up for my newsletter here. 

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