Dudley Chides Fed’s ‘Sugarcoating.’ El-Erian Warns Of Inflation ‘Crisis’

In late March, around the time the 2s10s inverted, Bill Dudley penned a somewhat abrasive Op-Ed for Bloomberg.

Dudley isn’t a stranger to abrasive Op-Eds, but in this case, he targeted his former colleagues, blaming the Fed for inflation and suggesting a so-called “soft landing” for the US economy was very unlikely.

In fact, he all but suggested a benign outcome was a mathematical impossibility. He cited the Sahm Rule (figure below).

In short, if the three-month moving average of the unemployment rate rises by a half percentage point or more, a downturn can’t be avoided. “To create sufficient economic slack to restrain inflation, the Fed will have to tighten enough to push the unemployment rate higher,” Dudley wrote, on March 29.

Fast forward several weeks and Dudley’s view is becoming consensus. There’s now widespread agreement that the Fed will be compelled to engineer higher unemployment in an effort to help balance supply and demand in a hopelessly distorted labor market, where evidence of the dreaded wage-price spiral is beginning to manifest.

Although Fed officials generally insist they see no such evidence, such protestations rely on a very generous interpretation of recent data which showed, among other things, that compensation costs rose at a record rate during the first quarter, when unit labor costs soared alongside plunging productivity.

Suffice to say Dudley isn’t predisposed to any generous interpretations.

In remarks to Bloomberg following another dour CPI report on Wednesday, Dudley accused the Fed of “sugarcoating” the situation. The Fed, he said, needs to hike rates enough to slow the economy and drive up unemployment. He sees no utility in the kind of euphemistic assessments favored by Jerome Powell and other Fed officials, who are understandably loath to talk in explicit terms about deliberately engineering what, under any other circumstances, would count as objectively undesirable economic outcomes.

During last week’s post-FOMC press conference, Powell persisted in the notion that the Fed can pull off what he’s taken to calling a “soft-ish” landing. “We have a good chance,” he mused, leaning on a familiar list of talking points including the notion that households still have “excess savings” or, at the least, buffers that are “substantially larger” than they might have been during previous cycles or compared to trend. The labor market, he said, doesn’t “seem anywhere close to a downturn.”

Powell repeatedly cited the ratio of job openings to the number of Americans counted as unemployed. Using the latest JOLTS data, documented here last week, the number is 1.9. That is: There are nearly two jobs for every person counted as unemployed.

That suggests the Fed’s task is to create just enough drag to squeeze out superfluous job openings while avoiding any actual job losses. Goldman, another former Dudley employer, summarized this late last month. “The key to a soft landing is to generate a slowdown large enough to persuade firms to shelve some of their expansion plans, but not large enough to trigger sharp cuts in current output and employment,” the bank’s Jan Hatzius said.

We all know that’s not going to happen, though. Hatzius was diplomatic. “Slowing growth by just the right amount may be easier said than done,” he remarked.

For his part, Dudley is done being diplomatic. “The Fed should be more forthright about explaining [this] to the American public,” he insisted, suggesting Powell’s efforts to “sugarcoat it” are preventing financial conditions from tightening enough, while simultaneously risking America’s confidence in the institution.

I’m not sure how much time Dudley spends on Twitter, but I’d gently note that at least some Americans lost confidence in the Fed a long time ago.

Dudley had a modest suggestion. “I think it’s 4 to 5%,” he told Bloomberg, referencing where rates need to go in order to bring down inflation. “It wouldn’t shock me if I’m [at] 5 to 6 a few months from now.”

Meanwhile, during a CNBC cameo, Mohamed El-Erian warned that the country is teetering precariously on the brink of a “cost-of-living crisis.” Last week, El-Erian told Bloomberg’s Jonathan Ferro that the Fed “has a credibility issue with the American people.” In the same appearance, he chided Powell for so readily repudiating rate hike increments larger than 50bps. “We don’t know enough about the path of inflation to rule out certain policy actions at this point,” El-Erian said.

What’s obvious, with the benefit of hindsight, is that Larry Summers, El-Erian, Dudley and a long list of other policymakers-turned pundits and sundry “name brands,” were mostly correct about inflation and the perils of the Fed’s delayed response to the burgeoning threat.

Of course, everything’s obvious with the benefit of hindsight. What’s less obvious is whether Summers, El-Erian, Dudley or anyone else, would’ve had the fortitude to hike rates aggressively starting midway through 2021. Or now, for that matter.