It’s (Still) The Economy, Stupid

On Thursday, I channeled a popular derivatives strategist in describing the idea of a Fed pivot as “wishful thinking.”

The rationale for that characterization is straightforward: US Inflation is nowhere near target and base effects or not, it’s exceedingly difficult to imagine CPI or PCE retreating to palliative (let alone palatable) levels anytime soon.

Of course, the Fed’s capacity to engineer a meaningful reduction in price pressures is a function of policymakers’ willingness to risk a recession. The only way the Fed can solve a negative supply shock is by orchestrating an offsetting decrease in demand. That means chancing higher unemployment and an economic contraction.

Frankly, I’m tired of hearing about how the “best way” to combat inflation in its current incarnation is to address supply chain frictions. As things stand, that’s like telling someone with no money that the best way to fix their broken car is to buy a new one. That is: Yes, obviously the best way to alleviate inflation driven primarily by ongoing supply chain problems is to fix the supply chain problems, but that’s a tautology. And not even a clever one. We can’t fix the supply chain problems expeditiously and as we found out over the last two years, they’re not inclined to fixing themselves.

So, we can either wait around some more, or else bleed demand until the existing supply of goods, services and workers is sufficient to meet whatever’s left of it (demand) once we’re done with the bloodletting. With apologies, that’s the only option we have. It’s either that, or convince Xi to abandon his draconian approach to COVID containment, and cajole Vladimir Putin into leaving Ukraine. If you’ve got any great ideas about how to accomplish either of those things, I’m sure Washington would be all ears.

Forced demand destruction is suboptimal, especially in an election year, but it’s the lesser of two evils, both economically and politically. After all, politics is just “the economy, stupid.” And no, that strategic talking point isn’t past its expiration date just because the US economy no longer works for anyone besides “red-blooded capitalists” like Jamie Dimon. As Donald Trump made abundantly clear, regular people can be made to believe that the economy and the stock market matter to them, even when they don’t, just like they can be made to believe that a nine-years-dead Venezuelan dictator hijacked voting machines from beyond the grave, even when he didn’t.

Besides that, this is the kind of economic problem that really does matter to everyday voters. They may not benefit from higher stock prices, but they sure do get hurt when the cost of gas and food accelerates into the stratosphere. If you wanted to sow the seeds for Trump’s return, you’ll note that high inflation is fertile ground for populism, ironic because populism is itself conducive to high inflation.

Joe Biden’s poll numbers have plummeted, and it’s no secret why. The simple figure (below) plots Biden’s approval rating with annual CPI.

Note the annotations. The problem isn’t the Taliban. And it’s not Putin either, although if Biden’s polling gets even worse, he’ll be indirectly responsible because Russia’s misbegotten Ukraine adventure made an already bad inflation situation much worse. I’d say “immeasurably worse,” but it is possible to measure it. We’re measuring it every day via various commodities indexes, all of which flew off the proverbial charts following the invasion.

Biden’s approval was highest when he handed out (more) free money to Americans. That’s not a coincidence. People like free money, and free money helped juice the economy. A juiced-up economy, record-high stock prices and stimulus checks are a recipe for favorable approval ratings. There again: It’s the economy, stupid.

But if the Fed doesn’t wrestle inflation down from “stupid” levels, the economy is going to correct the problem on its own. People can’t buy what they can’t buy. Eventually, demand will crater to correct for higher inflation and it’s at least possible Bill Ackman was correct to suggest that if this does have to happen on its own (i.e., despite an insufficiently hawkish Fed rather than because of a hyper-aggressive Committee), the result could be a loss of investor confidence.

So, the Fed will keep hiking. There’s no support for a September “pause,” let alone an overt dovish pivot. Raphael Bostic said it might make “sense” to pause, depending on the data. He didn’t say anyone was currently planning for it. That was a mainstream media fabrication.

If you don’t believe me, ask Lael Brainard. “Right now, it’s very hard to see the case for a pause,” she told CNBC Thursday, in her first interview since being confirmed as Vice Chair. “We’ve still got a lot of work to do to get inflation down to our 2% target.”

That latter point was an understatement. I realize this is repetitive, but the Fed can’t even see 2% (figure below) and I’m not convinced the math is “there” (so to speak) for the balance of 2022.

Brainard generally refused to speculate about the appropriate path for rates beyond the next two meetings, but said it may well be appropriate to hike 50bps in September instead of 25 “if we don’t see some of that really hot demand starting to cool a little.”

Specifically, Brainard said she wants a “consistent string of data” suggesting inflation is receding.

You’re reminded that if MoM prints are what counts, as Loretta Mester has suggested, we don’t even have one print that suggests price pressures are abating (figure below).

Speaking of Mester, she too weighed in on Thursday. “I do believe we need to get interest rates up to a longer-run neutral level” as soon as possible, she told a virtual audience after a speech to the Philadelphia Council for Business Economics.

She reiterated her preference for consulting the monthly prints.

“If by the September meeting, the monthly readings on inflation provide compelling evidence that inflation is moving down, then the pace of rate increases could slow,” she said, adding that if inflation “fails to moderate,” it might be “necessary” to go “faster.”

Mester also said that “with inflation as elevated as it is,” the Fed will likely need to hike rates into restrictive territory.

According to Gallup’s polling, the only two presidents who “enjoyed” an approval rating as low as Biden’s in May of their second year in office were Jimmy Carter and, of course, Donald Trump.