“We all get the joke,” Nomura’s Charlie McElligott wrote Tuesday.
He was referring to the “never-ending” deluge of memes and commentary lamenting a Fed condemned to making people poorer no matter what they do.
Staying behind the curve — which in this case could mean hiking “only” 50bps or failing to get rates into restrictive territory posthaste — risks embedding an inflationary psychology in the economy. Expectations matter, and they matter a lot. If the public gets the idea the Fed is totally powerless in the face of generationally high inflation, that loss of confidence could become a self-fulfilling prophecy.
But going all-in, Volcker-style, risks “driving the economy off a cliff,” as Elizabeth Warren very calmly explained, while lecturing Jerome Powell on Capitol Hill last week.
Read more: Fed Up
At this point, though, the Fed is duty-bound to risk a recession. They’re statutorily obligated. The employment side of the mandate is met. And then some. If they don’t step up the inflation fight, they’re derelict.
As I wrote in the linked article (above), if Congress is concerned that the Fed doesn’t have the right tools to combat all kinds of inflation and that, as a result, policymakers will periodically end up resorting to draconian rate hikes that pose an unacceptably large risk to growth, lawmakers have three options. They can give the Fed better tools, they can soften the Fed’s mandate or, ideally, they can take a break from perpetuating gridlock and do something to impact the supply side of the equation.
In the meantime, central banks have to move. “Inflation will continue to surprise in its ‘stickiness’ and strength over the upcoming months, particularly as it moves into services, even with the coming ‘bull-whip’ disinflationary goods impact,” McElligott said.
He noted that the Cleveland Fed’s inflation nowcast is currently projecting another uptick in YoY CPI (figure above). As of Tuesday, the projections were for headline consumer prices to rise 1% MoM and 8.7% YoY in June.
If inflation stays elevated, it won’t be a mystery, McElligott said. “High inflation means volatile inflation and inflation tends to trend,” he wrote, citing colleague Anthony Morris.
The figures (below) speak for themselves, but just in case, there are plenty of annotations.
The read-through for monetary policy isn’t especially encouraging if you’re waiting patiently for a return to the kind of staid, predictable forward guidance that characterized the post-GFC era.
Central banks are in reactive mode, which in this case means responding to incoming evidence of inflation’s persistence. The resultant “hawkish impulse will continue to reinforce the negative impact in rate- / credit-sensitive parts of the economy, effectively ‘self-fulfilling’ a recession, as consumer sentiment plummets and broad activity loses momentum,” McElligott cautioned.
On the bright side, that’s preferable to a self-fulfilling inflation spiral.
You must be logged in to post a comment.