The Fed is making a big mistake with its outsized interest rate hikes as inflation turns into deflation, Ark's Cathie Wood says

• Cathie Wood believes the Fed has gone too far in its bid to tame inflation via interest rate hikes.
• She argues that the Fed is overly focused on lagging indicators that show inflation, while leading indicators show signs of deflation.
• "Even the oil price has dropped more than 35% from its peak, erasing most of the gain this year," Wood said.

Fed Chairman Jerome Powell is making a mistake as he continues on a path of outsized interest rate hikes to tame inflation, according to Ark Invest's Cathie Wood.

That's because inflation is quickly turning into deflation, she said, and that means the Fed will likely have to pivot away from its interest rate hikes sooner than the market thinks.

Making matters worse, according to Wood, is the fact that the Fed is overly focused on lagging indicators like employment and core inflation, rather than leading indicators which show signs of deflation.

"Leading inflation indicators like gold and copper are flagging the risk of deflation. Even the oil price has dropped more than 35% from its peak, erasing most of the gain this year," she said in a tweet on Wednesday.

Commodity prices have indeed plunged in recent months, and some are trading at or near levels not seen since prior to the pandemic. Gasoline prices in particular have dropped precipitously since the average price for a gallon of gas briefly jumped above $5 in the US. It has since fallen to $3.75 per gallon, according to data from AAA.

"In the pipeline, inflation is turning into deflation," Wood said.

"One of the best inflation gauges, the gold price peaked more than two years ago in August 2020 at $2075 and has dropped ~15%. Lumber prices have dropped more than 60%, copper -30%, iron ore -60%, DRAM -46%, and crude oil -35%," she explained.

And a reversal of inflation into deflation could be compounded by the fact that retail inventories have soared in recent months, which could lead to steep discounts for consumers during the upcoming holiday shopping season.

If inflation is about to turn into deflation, as Wood suggests, then the Fed could find itself in a scenario where it over tightened monetary policy and needs to pivot to prevent the economy from entering a hard downturn. The Fed is still expected to raise interest rates by another 75 basis points at its FOMC meeting later this month.

Comparing Powell to former Fed Chairman Paul Volcker, who reined in inflation in the early 1980's with massive interest rate hikes, Wood said Powell's current Volcker playbook doesn't match the economic environment.

"Faced with a two year supply-related inflation shock, Powell is using Volcker's sledgehammer and, I believe, making a mistake," Wood said.

"The Fed seems to responding to COVID-related supply shocks spanning 15 months the same way that Volcker battled inflation that had been brewing and building for 15 years. I would not be surprised to see a significant policy pivot in the next three to six months," she added.

A potential about-face by the Fed would be welcomed by growth investors like Wood, who often buy companies that are not yet profitable and rely on a low cost of capital to fund their business. Surging interest rates have dinged Ark Invest's flagship investment fund, with the Ark Disruptive Innovation ETF falling 74% from its February 2021 peak.