“We see the arguments for a 50bps rate hike in March,” Goldman’s David Mericle and Jan Hatzius said, in the course of updating their Fed call yet again. They now see seven hikes in 2022.
Although the bank didn’t adopt 50bps as their base case for the March meeting, Goldman did say they’d “consider” it “if other participants” join Jim Bullard in calling for an outsized move — “especially if the market continues to price high odds” of a bigger increment at next month’s gathering.
The market pricing bit is important. “Behind the curve” is no longer sufficient as a description of the Fed’s policy stance vis-à-vis realized inflation. “Dangerous” is better. The Committee likely realizes that, and may see aggressive market pricing as a green light.
“At this point, financial conditions remain at historical lows [and] despite that, markets have squeezed in expectations of a couple more hikes in a short span of time,” Bloomberg’s Ye Xie wrote, adding that “Fed policy impacts the economy through financial conditions, so relatively loose conditions offer the Fed a ‘free’ option to deliver super-sized rate increases.” The figures (below, from Goldman), illustrate the point.
Goldman reiterated their own version of the same general argument. “The bond market… is now pricing over six hikes this year, but financial conditions have only tightened moderately so far, mean[ing] the negative impulse to GDP growth is still limited,” the bank said. That, in turn, “suggests more tightening is likely to be required to generate the slowdown that the economy needs.”
Note Goldman’s use of the term “needs.” To the chagrin of many (including myself), it’s now obvious that if there’s a policy conjuncture capable of serving up a free lunch, we haven’t discovered it yet. I discussed this at length in “Crying Over Expensive Milk (No More Free Lunch).” Specifically, I noted that although “I still believe” a free lunch is possible, “we were dealt the wrong crisis.” The linked article went on to say that,
One could conjure any number of exogenous shocks that would’ve compelled the same policy rethink (i.e., the institution of fiscal-monetary partnerships) without the accompanying inflation. The nature of this shock was incompatible with many key disinflationary forces (e.g., globalized supply chains), even as it magnified others (e.g., too much debt). In any case, the free lunch idea is out for now.
We waited (and waited and waited) for various distortions, disruptions and frictions to work themselves out, and they didn’t. It’s been two years since the onset of the pandemic. Inflation is embedding itself in the economy.
Yes, demand destruction is likely to set in on its own. The spending impulse is already waning and, as Morgan Stanley’s Mike Wilson has noted, the inventories gift may soon become a curse.
But we can’t wait around anymore. Policymakers absolutely cannot risk runaway inflation in the developed world. There has to be a bastion of stability, or the entire system will collapse.
I realize this might not be apparent to folks without access to 24-hour news feeds, but fresh evidence of imminent peril comes in at regular intervals pretty much around the clock. On Friday, for example, RBNZ said two-year ahead inflation expectations among businesses in New Zealand hit a 31-year high in the first quarter. One-year ahead expectations hit 4.4%.
Central banks have to slam on the brakes. If that means tightening into a downturn, that’s what it means. As Goldman put it, the Fed likely thinks the economy “needs” to slow down. “The level of the funds rate looks inappropriate, and the combination of very high inflation, hot wage growth and high short-term inflation expectations means that concerns about falling into a wage-price spiral deserve to be taken seriously,” the bank said, adding that, “We could imagine the FOMC concluding that even a meaningful risk of an outcome as serious as a wage-price spiral requires a more aggressive and immediate response.”
Again, I do think fiscal-monetary partnerships can offer something like a free lunch in advanced economies with sufficient monetary sovereignty. But the nature of the current crisis rules it out for now, because the pandemic short circuited multiple key disinflationary forces.
For a few months, it looked as though we’d discovered El Dorado. We rescued the economy, handed out billions, drove up asset prices and inflation still looked subdued. Now, we’re left to ponder the distinct possibility that it was all a mirage.
If the inflation situation doesn’t improve posthaste, we may find ourselves searching for salvation in the jungles of South America.
I know there is little value to this thought exercise, but I also think it something we shouldn’t forget. Maybe it wasn’t such a great idea to have sustained QE while the economy was running hot, before the pandemic showed up, because some orange faced brat whined on Twitter in 2019? Inflationary effects are always longer term impacts of monetary policy, who’s to say that decision isn’t biting us right now?
I have often wondered if you have a bit of Jose Arcadio in you. Moving to Macondo?
I lived through the inflation of the late 70s and Paul Volcker’s aggressive rate hikes of the early 80s. When my wife and I bought our first house in 1984, we were lucky to get a 13% mortgage. But I also remember that unemployment soared to 10% as a result of Volcker’s actions. So which will it be, 13% mortgages or 10% unemployment? Is there no middle way?
for me the markets have largely been a mirage since 3/2020…while I see the US and World likely heading to a permanent higher price paradigm I’m still cautiously hopeful and reasonably confident that it will be digested markets and economy wise…I see inflation peaking relatively soon with an extended period of low and slow growth in store. Unfortunately I also see pain in small business and Russell companies that is likely unavoidable at this point.