Tension lingered Friday as shell-shocked investors pondered the prospect of an emergency rate hike from a Fed which, frankly, is flirting with a credibility crisis. The New York Fed released the final monthly schedule for Treasury purchase operations as planned, effectively ruling out an inter-meeting hike, but speculation around the Committee’s next move is at a fever pitch.
Critics will argue the Fed lost credibility decades ago, and that the only mandate the Committee actually pursues with anything like vigor is a shadow commitment to fostering and preserving bubbles in financial assets. If that’s your view, the current debate is superfluous.
At this point, though, even those of us inclined to observe decorum are compelled to acknowledge that Jerome Powell is wading into dark waters. Inaction isn’t an option anymore. The optics are very poor. Whatever the “flexible” meant in “flexible average inflation targeting,” it’s safe to say the Fed is out of flexibility. The figure on the left (below) is a testament to that.
The figure on the right (above) speaks for itself, but just in case, I endeavored to be unequivocal in the heading, subheading and caption. The Fed’s current policy stance is parody.
It no longer matters whether rate hikes are an effective tool given the nature of price pressures currently bedeviling the world’s largest economy. I don’t think they are. Raising rates isn’t going to fix disrupted supply chains. Or bring workers off the sidelines. Fed officials readily admit as much, but they simultaneously (sometimes in the same breath) insist they’ll do what’s necessary to control inflation using “tools” they swear are “very powerful,” to borrow the Bank of Japan’s language.
If monetary policy is impotent in the current environment, the Fed should just say so. If it’s not, they need to act. It isn’t an exaggeration anymore to suggest that inaction chances irreparable damage to the institution. If anything we claim to know about monetary policy and economics is even a semblance of true, there’s no case whatsoever for keeping rates at zero and continuing to purchase assets with newly-conjured fiat money. Not even for another day.
Persisting stubbornly in that policy bent when every, single data point is conspiring against you, is madness and reflects an almost pathological arrogance. Powell has taken to preaching “humility” lately. Well, there’s not much humility in the Fed’s current posture, which, again, amounts to deliberately tossing kerosene on a raging bonfire that’s creeping closer and closer to a parched forest.
Note that all of this is predicated on the notion that monetary policy can make a difference. I’ve repeatedly suggested it can’t given the proximate cause of inflationary pressures post-pandemic. But if the Fed intends to stick with the notion that monetary policy is capable of putting out the fire, then policymakers need to grab the extinguishers.
Currently, inflation in the US is purely a supply-demand problem. But a Fed that stands idly by a fire while insisting loudly that if they wanted to, they could put it out, runs the risk of sowing the seeds for a crisis of confidence in the currency.
Obviously, the US is nowhere near that tipping point. And because the dollar dominates cross-border trade and settlement, there’s an argument to be made that shifting away from it simply isn’t possible, regardless of what happens in the US economy or on the US political scene.
Nevertheless — and I never thought I’d have to say this — the risk of hyperinflation in the US is now non-zero. The public has almost no faith whatsoever in America’s institutions, and that includes the country’s many technocrats and bureaucracies. It’s not terribly difficult to imagine a scenario where a skeptical populace, fed up with anything and everything, starts asking uncomfortable questions about why the fire department isn’t putting out the fire.
If politicians become too concerned about the issue, it’s possible Congress decides the Fed can’t be trusted to follow its price stability mandate anymore. Of course, the last people you want in charge of monetary policy are politicians.
The stakes are getting higher by the hour. Literally, from a confidence perspective. The Fed needs to hike rates immediately and cease and desist from buying bonds. If they don’t, they may look up a year from now and discover that supply chain disruptions and wage-price spirals are the least of their problems.
OMG where did this come from? The Fed is ending purchases shortly, and by all accounts intend to hike rates either by 25 or 50 bps in March. The CPI print was bad, but are they supposed to panic because the number was 7.5% not 7.3%? I grant there was some broadening of price hikes but really this is a very hard to measure metric and odd bounce in prices and the economy. Central banks are on the right track- they are adjusting to circumstance. Inflation is a problem but it is one we know how to manage- tighten monetary policy and help the supply chain recover. Once consumer market baskets start to normalize more and the progression of the disease gradually unwinds, you will see inflation recede as long as monetary policy adjusts- there really is no need to panic or slam on the brakes.
Sorry, but give me a break. At some point, rational people have to come to terms with reality. This is a companion article to the Biden piece from Thursday. It is what it is. The Fed’s stance is ludicrous. Central banks aren’t “on the right track.” They’re flat-footed, and they’re panicking. Anyone who’s being objective is compelled to admit as much.
I’ve said this time and again: This site is fact-based opinion and analysis. In that order. Facts inform the opinion and analysis, not the other way around.
It’s great when my own opinions and biases line up with the facts. That makes it easier. Right now, they don’t. So, the facts take precedence.
We’ve disagreed a lot in the year I’ve been reading your pieces. It’s a relief to hear a voice like yours change opinion. It gives me hope the fed will as well.
The reality is that they have to hike rates soon and for how long and how much who knows? Still this is not a dire situation or one we do not know how to address. Maybe they have to go 50-100-150 in total- maybe more? As far as the balance sheet goes given the new state of the financial market liquidity, winding down the balance sheet is a terrible mistake- just use rates. I thought they should have wound down Q/E a little bit sooner, like starting last summer. But that really is hindsight. In this particular case, the risk a year ago is that the Fed would wind down stimulus too soon not too late.From a risk management perspective they did the right thing. Sometimes in trading and policy making you take your shot- and many times even if the odds are in your favor you lose. Hindsight is 20/20. The Fed is making adjustments so that is good.
Well put, RIA. conditions are already getting tighter – see junk bond spreads. Markets and pundits are trying to force the Fed into a reckless tightening because wages are finally rising for the first time in 30 years. To quote Bob Marley, they must “kill it before it grows.”
But then, the US central bank is politically constrained against interfering in asset price inflation. Target housing? Are you kidding? Touch that sector and every local builder will be screaming at their reps in congress demanding that they rein in the Fed. So they have to raise rates and hammer the whole economy instead.
Good point. Do you think Hatheway and Friedman in Barron’s this week think of themselves as “rational”? Me? Color me alarmed!
“Let’s hope the Fed has made the right diagnosis and ignores the echo chamber of alarm coming from Wall Street.”
Wild note! Feels ignorant to the whole idea of patiently waiting for real-time data to flow in and adjusting course in a well-messaged, data-backed method. They should hike immediately to save their credibility and public image?? Into, by many accounts, a slowing economy and right after peak inflation? As you mentioned H the hikes won’t even have an effect on inflation, but they should panic hike to satisfy permabears and the average, monetary-policy-ignorant American’s view of the Fed? Feels somewhat like this was written by Biden admin scared of November
“…patiently waiting for real-time data”
Have you seen the data? It’s bad.
“They should hike immediately to save their credibility and public image??”
Yes. Because the dollar, like all money, has no intrinsic value. The entire system is one giant confidence game. Supply-demand imbalances will work themselves out. Confidence isn’t so easily regained once it’s lost.
I benefit a lot from H’s articles and comments, beyond economics. Thank you, H.
Thank you RIA for conveying what I was thinking…
You’re worried about hyperinflation, so the solution is to stop giving banks more money for bonds, and instead to hand them more money as interest? That’s a lot of reliance on some unquantifiable psychological manifestation of Fed policy.
Ideally we’d raise taxes to suck some money out of the economy, instead of pretending like one form of monetary stimulus is significantly different than another. But even if that doesn’t happen, it’s a little hard to see where hyperinflation comes in if the fiscal tap stays off.
Hyperinflation results from a loss of confidence in the currency. That may be tied to something fundamental (policy largesse in modernity or, historically, devaluing coins), but it may simply result from people deciding they don’t trust the issuing authority anymore.
I do believe monetary policy can impact this round of inflation, just not in traditional terms of inflation fighting. The current state of Fed easing enables a business to generate non-operational profits. That is to say “paper profits”. A business can borrow for less than it costs to operate, move debt around, generate money from this movement, and buy back shares to increase corporate valuations and entice investors. With this current model, it’s easy for a business to disconnect from the real economy and not concern itself with solving the problems of inflated goods and services or under-employment. Flipping to QT will force these businesses to evaluate how they are operating and actually invest in improving operations which will then require them to actually produce some goods and services to sell, otherwise they become insolvent. This shift in priority will force them to figure out how to get goods moving which will lead to a hiring spree and, eventually reduce inflation.
The Fed should have acted 6 months ago when it finally acknowledged that inflation wasn’t “transitory”. Siting on its hands with forecasted plans to react to a miscalculation in inflation projections is, as you put it, arrogance. It’s too late to prevent permanent inflation now, the longer they wait the higher that permanent inflation goes. Stocks are going to get crushed, it’s called bubble finance for a reason. Bubbles are not intended to be permanent, if you’re investing in this economy you have to recognize when they are inflating and when they will deflate. Inflation is the straw that broke this bubble’s back.
If people lose confidence in the currency, what are they going to trade it for? Inflation is hitting the worlds fiat equally, so not much luck there (and who wants to win the race to a stronger currency, anyway? Nobody). Gold hasn’t budged.
I guess people could start bartering more, but i think you’d need some venezuela-style inflation to make that worth anyones time, and you only get that level of inflation with consistent fiscal stimulus far beyond the productive capacity of the economy, not just people suddenly saying “milk costs 10% more than last year, ive lost faith in the dollar and instead will barter my services with the local farmer for milk.”
Every single historical fiat currency failed. They were all replaced with something else. Humans figure out a way to keep money going.
All currencies are “fiat” currencies because the value of any medium of exchange, even gold, depends on the acceptance of those who would use it.
Jon, you’re preaching to the choir. I’ve been writing just what you wrote for years on this site (and years before that elsewhere).
The problem right now is that the data (i.e., reality) simply isn’t cooperating anymore. I don’t like it anymore than you do. 🙂
I’m not doubting your creds (i ended up here after Kelton gave you a shoutout, after all), just not seeing the connection between another month of 7% and the immediate need for the Fed to do something, even if that something is just “looking busy for the cameras”.
The problem here is that Powell has already conceded the feds inability to impact employment. If the fed also relinquishes its mandate to affect inflation then they will have to answer the question of why they exist. The “uncomfortable questions” h points to are precisely this.
I would hope the fed wouldn’t want the public to come to the conclusion that the feds “real” mandate is financial markets instead of the real economy.
One thing that’s bothered me about this whole pandemic inflation debate is the horror everyone expresses about the possibility/likelihood of a recession — as if the American economy hasn’t cycled through booms and busts, sometimes major ones, for the last 240 years or so. Eugene Fama notwithstanding, equilibrium is not a steady state in capitalist economies; capitalist economies move through equilibrium from boom to bust and back again. It’s what they do. Are we headed for a Fed-induced recession? Probably. Will it help to bring down inflation? Most likely. Should the Fed be excoriated for its lateness to the party and for “allowing” a recession to happen on its watch? Maybe a little. But remember, the Fed took heroic action to keep us from falling into a much deeper recession — maybe even a depression — two years ago. The Fed wins some, it loses some, but mostly it manages to deliver on its mandates.
The Fed can not fix this situation- only private business and (unfortunately) elected politicians.
Open ports/logistics 24/7
Stop relaxing rules to obtain disability assistance. The enrollment numbers have skyrocketed. If someone hurt their back- they need to find a job that does not hurt their back.
Public/private alliances to relieve truck driver and chip shortages.
Etc.
The Fed pontificating over QE, balance sheet tun off and quarter- half point interest raises is getting very annoying to listen to. Like sprinkling baking soda on a kitchen grease fire instead of using the fire extinguisher held by public/private entities.
I am in for the long haul (and am not worried) and I am trying to tune out the media/news (and not look at my account balances) – even more than I was.
People in the US have expenses in dollars. Taxes, mortgages, etc. are priced in dollars. How can one lose confidence in dollars if one is legally required to pay taxes, mortgages, etc. in dollars? When a person is required to pay expenses in dollars, the statement “the dollar … has no intrinsic value” is meaningless. The dollar is the unit of account in the US and Ecuador for various “contracts” like taxes and mortgages. To a person who has to pay $3000 each month (on fixed, low interest mortgages on real estate properties), $3000 is necessary and valuable, independent of the price of gasoline or apples or natural gas. Try sending a few bags of potatoes to the IRS instead of the appropriate number of dollars to pay your income taxes and see what happens.
This comment is an exercise in question-begging. You value the dollar because you know I value it and I value it because I know someone else values it and so on and so forth. That’s why contracts are denominated in dollars. It’s a confidence network. Besides organized religion, it’s the strongest confidence network the world has ever known.
But it can break down. At which point people would stop writing contracts in it. They’re already doing that in DeFi, although, as I’ve argued on social media, the biggest problem with DeFi right now is that it all ultimately comes back to people’s desire to convert their tokens to USDC (the fully-backed crypto USD).
However, what you’ll quickly start to figure out if you immerse yourself in DeFi, is that you actually can’t do anything without Ether. You have to have Ether to pay gas fees and you have to pay gas fees to get anything done. If you can’t pay the gas, you can’t do anything. And USDC won’t work. Just like the IRS doesn’t accept Ether, Ether-based protocols don’t accept dollars for gas. Sure, you can add $3,000 USDC to your wallet and then convert it to Ether to buy an NFT for 1ETH, but by the same token (see what I did there?) you can convert Ether to dollars and then go pay your $3,000 tax bill. If people start building apps other than DeFi apps on Ethereum (and they already are), Ether will become sought after for its own sake.
Further on taxes, that works right up until so many people simply refuse to pay that the government’s capacity to enforce an arbitrary dictate is exhausted. Obviously, we’re nowhere near that point yet. As you suggest, it’s scarcely worth speculating about. But as you may have noticed, rich people and many corporations already don’t pay taxes. Not in dollars, not in potatoes and not in anything else either. How long before regular people decide they’re not going to pay either? They’re already storming the Capitol with spears, after all.
The point is, this is all made up. None of it is real. As such, it can collapse. It really, really can. You need confidence. And it’s the Fed’s job to protect that confidence. They need to do their job. Period.
Color me stupid, but are you saying the masses will lose their magical faith in dollars and, instead, pledge it to Ether?
I guess they don’t have taxes in turkey…
Once the legal system breaks down, we will have much more serious issues than the worth of the dollar. In the long run, confidence in the dollar is extremely important. Over the next five years, the functionality of the dollar as a unit of account and a medium of exchange will remain strong while its role as a store of value may suffer. Fears of hyperinflation seem overblown. On the other hand, most readers here would probably benefit from hyperinflation, just as purchasers of real estate during the hyperinflation in the 1920s in Germany benefited while sellers of real estate say the value of their currency vanish.
Among Ur many excellent and thought-provoking articles, this article is one of Ur very best Mr.HeisenB. And the companion piece about executive branch also pointing out some inconvenient realities that are piercing the narrative. Ur reference to a skeptical populace reminds me of the current conflagration in Canada of truckers paralyzing cross border supply chains. And what’s the point of litigating either polarity about vaccine mandates when most agree that Omicron is fizzling out. Ford, Toyota, and GM have announced production delays due to supply chain interruptions. Gee, I wonder what that will do the automotive component of how inflation is calculated when it was damn near impossible to buy a new truck or SUV at MSRP before GM, Ford and Toyota just announced delays in further production.Truckers in the US are inspired by their Canadian brothers and sisters to start their own protest when we already have a shortage of truckers. What will that do to the nascent recovery of supply chains that is being touted by the authorities preaching patience ?? So even though I agree that monetary policy needs to swerve in all the ways U recommend Mr. H, I think we can agree that relentless blathering on the financial TV channels about 5 or 7 rate hikes ignores the real time events happening on the ground that will disturb the economy beyond the already dismal toll of inflation. (and I won’t even mention the relentless upward march of oil prices since official numbers released late yesterday confirmed that OPEC isn’t meeting their supply targets)
As far behind as the Fed is, can we talk about how delusional the ECB appears to be? It appears inflation is just getting started overseas, and energy prices are going to be a huge part of overall inflationary pressures. I don’t get their continued dovish stance.
An immediate end of QE seems warranted but at this point I think it best for lift off to commence in March, with an a likely 50 basis point move. A panicked and impulsive Powell / FOMC at this point would be far more detrimental than good for all concerned.
I wonder what the Fed thinks about how inflation will develop in the coming years.
Why does it matter what they forecast – aren’t they incompetent and doesn’t the current way-hot CPI override everything?
There is no entity with a fraction of the economic and analytical horsepower of the Fed, with its unique access to non-public data.
Sure, the Fed has gotten this inflation cycle all wrong, and it got X and Y all wrong in the past too. Well, economies and markets are so complex and poorly-understood that even the best forecasters will be wrong a lot. The respected economists and strategists who get lots of attention are wrong most of the time. David Rosenburg, just to mention one, has been continuously wrong for decades.
So even when the Fed is throwing airballs, it will continue analyzing and forecasting and those forecasts – along with human failings and weaknesses like, sometimes, hubris or panic – will inform the Fed’s actions.
If the Fed believes that inflation will ease significantly in 2H, then it will not want to club the economy into a coma – or the markets into disorder – in 1Q just to accelerate the decline by a quarter or get the year-end level to 3% instead of 4%.
What this thread and much of the current ranting about Powell and Biden doing this or that … blah blah .. conveys is the level of general ignorance and or forgetfulness about how government in the US actually works (or doesn’t). Powell doesn’t set interest rates, the whole FOMC does that. The Fed isn’t a dictatorship, its a group of dithering supposed experts who must make group decisions. Likewise, Biden can’t raise or lower taxes, determine a budget, appoint key government department heads, judges, etc without authorization by the Congress. These folks pass laws and Biden only gets to approve them or veto them. For decades now people are railroaded to elect this or that presidential candidate based on what they will do. It doesn’t work that way. Though Trump gave it a good shot, even he found out there are significant limits to titular power. It’s the group that has to act not just the titular heads. The scariest thing in my view is the rising desire of Americans to have a dictator. Read you history again and rediscover what a bad idea that is. It’s why we are American, to get rid of the king. We often hear people say about war that we’ve got to keep fighting or the dead will have died in vain. You can say the same about our democracy. We need to keep fighting for it and against authoritarianism or millions will have died in vain trying to protect it.
We see this one differently H, I can’t disagree with the loss of credibility in the Fed and their ability to enact policy, but an emergency hike and further escalation of the hawkish pivot at this stage won’t really help that much with inflation and risks communicating severe panic. To me this is the bigger risk short term, panic and fear will only reinforce the notion that the Fed lost control. It is too late for a hike before March to have any discernible and positive impact, but it is not too late for the Fed to makes things worst by looking clueless and afraid in the way they react to data.
For those who are numerically inclined, I recommend reading Clarida’s papers on optimal monetary policy and review the model’s response to supply and demand shocks. You’ll notice that in both cases inflation spikes and then settles with mild changes to the short term interest rates.
I know, people will say (as they always do) that models are imperfect. Even if they are, I suspect this is what the Fed is using for guidance. I haven’t seen clear breakdowns in the model’s assumptions, and the assumptions are reasonable.
We’ll be fine with modest tweaks to policy. Powell and the FOMC, as good scientists as they are, seem to have trouble conveying technical outcomes in plain terms without causing panic.
I would love to read those – any handy links?
On 2/10, the Fed announced a previously unscheduled meeting under “Expedited Procedures” for Monday Feb 14th.
https://www.federalreserve.gov/aboutthefed/boardmeetings/20220214closed.htm
The matter to be considered is “Review and determination by the Board of Governors of the advance and discount rates to be charged by the Federal Reserve Banks”
So perhaps sometime next week the Fed will “surprise” the market and announce an immediate end to QE along with its initial hike in rates …
Obviously a provocative article, given that the comment thread is the longest I can remember since you have gone to this platform. It’s a month or so to the next Fed meeting. Most of what is happening that is exacerbating inflation is beyond their control. Given that the communication hasn’t been their strong suit, doing anything prior to the meeting runs the risk of creating the opposite effect of whatever they are trying to achieve. Do the 50 next month, the pandemic pull forwards, incompetence out of DC (gridlock), and consumer sentiment will take care of the demand side of things. Hopefully for Biden, he doesn’t dust off Carter’s “malaise” speech.
I enjoyed reading the article as much as reading all the comments. What a superb website H !
We are in a chicken and egg situation. Do we immediately taper/destroy demand to counter supply problems ? What if that in itself stops the repairs being made to our supply system because the demand is gone all of a sudden. Surely this is the worst possible outcome. Demand must be slowly tapered so supply system repairs can continue and catch up.
Back in 2020, the Fed was confronted with a Covid crisis leading to an economic crisis leading to a possible financial crisis globally. A trifacta crisis that would have been absolutely miserable had it all happen at the same time. The Fed and the governments did the right thing to keep things contained to mostly a covid crisis and prevent an economic and financial crisis from fully developing in most of the developed world. Now that Covid crisis is mostly over, they may risk a short term economic crisis to avoid a larger financial crisis, BUT huge part of the rest of the world is just coming out of their covid and economic crisis and some countries financial crisis….if FED steps on the brakes fast, expect another huge economic and financial crisis in the the developing world.
The inflation data is indeed bad. When you look at oil and job picture(low inflation and wage spiral), it is scary. I am not seeing an end in sight for those two items and that calls for sustained rate increase. We are likely 2-3 months away from inflation picture easing from the data I am seeing and little bit of demand destruction will help ensure that stays on track….confidence surveys are alluding to this. Additional liquidity withdrawl can also help so I still think they will do gradual rate hikes, end taper, deflate markets, crypto and housing bubble (to a lesser extent). No need for panic, February will be bummpy but Spring will see some light at the end of the tunnel.
Forgot to add Larry Summers is an asshole for being so blunt and vocal on Bloomberg on Friday essentially preaching to the Fed what they must do immediately. He obviously appeared panicked….why not whisper the same in Powell’s ear rather than soap box of Bloomberg.
In my day job, I see daily receipts from a nationwide base . I’d expect that many in similar situations have seen, as I have, the impact of inflation over the last 9 months.
I’m just a simple social science guy, but with all due respect to Dr. Friedman, inflation is also, always and everywhere, a social-psychological phenomenon.