Hubris And ‘Dangerous Groupthink’

Christopher Waller wasn’t prepared to unequivocally endorse a 100bps rate hike at this month’s FOMC meeting.

He did, however, acknowledge that June’s CPI report counted as a “major league disappointment.” Much like a Fed that lets inflation accelerate to 9.1%. (Sorry, I couldn’t resist.)

Waller spoke Thursday at an event in Idaho, where he stopped short of prescribing the all-in approach adopted this week by the Bank of Canada, which resorted to a massive rate increase and warned explicitly on the risk of a wage-price spiral. Instead, Waller indicated he could support such a move in the event data due between now and July 27 “come[s] in materially stronger than expected.”

He was referring specifically to retail sales figures for June, due Friday, and a raft of upcoming housing data, including starts and existing home sales next week and new home sales figures due out the day before July’s Fed decision.

It’s likely that Jerome Powell and Lael Brainard advised officials to avoid publicly endorsing a 100bps move in the interest of preventing market pricing (and public opinion) from boxing the Committee in. As discussed here on Wednesday, there’s a threshold beyond which the Fed has little choice but to validate expectations.

Markets are used to seeing that dynamic work in the opposite direction. In the post-financial crisis era, rates priced incremental Fed easing at the first sign of turbulence and policymakers chanced an unwanted tightening of financial conditions if they disappointed dovish market pricing. In 2022, the market is pushing the envelope on rate hikes, and while the Fed fully intends to keep raising rates aggressively, they likely aren’t enamored with the prospect of having to choose between hiking a full percentage point at a single meeting and being accused of abrogating their responsibilities at a time when they’ve already been indicted (figuratively speaking) on that count both in the halls of Congress and on Main Street.

Waller said as much in Idaho. “Don’t say because you’re not doing a 100 you’re not doing your job,” he told Bloomberg’s Michael McKee.

Not to put too fine a point on it, but that’s precisely what I meant Wednesday afternoon when, in the linked article (above), I suggested the Fed was at risk of having the proper course of policy (what’s “warranted,” to employ key language from the June meeting minutes) dictated to them given the sheer magnitude of America’s inflation problem.

He tried to walk markets back from the ledge. Bets on a 100bps move suggest traders are a “little ahead” of themselves, Waller advised. Still, he did say he’d “lean towards” supporting a full percentage point hike this month in the event the data suggests demand “isn’t slowing down fast enough.”

On Wednesday afternoon, Raphael Bostic said “everything” is on the table at this month’s gathering. Later, during a video chat with Bloomberg’s Kathleen Hays, Loretta Mester indicated that 75bps for this meeting is a foregone conclusion: “I have not seen any convincing evidence that inflation has turned the corner, right?” (Right.) “The markets are having a conversation and putting their money where their mouth is,” she went on.

Waller’s Thursday remarks managed to move markets back in the direction of favoring a 75bps move later this month, but if retail sales are even a semblance of robust, traders will be right back to pricing in 100. The same goes for inflation expectations in the University of Michigan sentiment survey, the last notable data release this week.

I assume this is obvious by now, but just in case: There’s no reason whatsoever to put any weight on the Fed’s economic forecasts or, for that matter, their expectations for the policy rate which they themselves set. Typically, when we say “your guess is as good as anyone’s” it’s a figure of speech. Here, you can take it quite literally. Your guess about the trajectory of inflation is as good as the Fed’s. Now if only you too could conjure genuine US dollars from thin air, you’d be all set.

Note that using the adjusted series as expounded in an NBER paper published earlier this month by a group of economists including Larry Summers, June’s headline CPI print is very close to being the hottest 12-month reading in American history (figure below).

As a reminder, Summers, Marijn Bolhuis and Judd Cramer found that past inflation peaks are lower using a consistent methodology. “The peak of the Volcker-era inflation (March 1980), currently understood to have been at 14.8%, is only 11.4% when adjusted for the switch from homeownership costs to OER,” Summers wrote.

It’s not just that the Fed isn’t “credible,” it’s that what they’re trying to do is impossible, a state of affairs to which nearly everyone in the world was blind until now. Powell, speaking alongside Andrew Bailey, Agustín Carstens and Christine Lagarde at the ECB’s annual forum in Sintra late last month, at least acknowledged the futility of it all, if only tacitly. “We now understand better how little we understand about inflation,” he told Francine Lacqua, to nervous laughter.

But hubris, like cocaine, “is a helluva drug.” And Summers, having stumbled into a spectacularly accurate forecast over the past 18 months, is high as a kite. “It is good that, very belatedly, the Fed is moving aggressively with respect to inflation,” he told New York Magazine on Wednesday, following June’s CPI report. “It would be helpful if they could forecast in a credible way,” he added, without irony. “That none of the 19 members of the FOMC expect unemployment at any point to exceed 4.5% suggests to me a dangerous level of groupthink.”

Summers is the “group” in groupthink. To the extent everyday Americans can name a living economist, it’s either Paul Krugman or Summers. He’s “polarizing,” as Benjamin Hart put it, not because he’s a contrarian, but rather because he’s abrasive and annoying. He’s synonymous with the establishment he so readily derides in pseudo-retirement.

And anyway, he misses the point. The lesson of 2020, 2021 and 2022 isn’t that it’s possible to correctly predict economic outcomes using standard models, as Summers claims to have done. It’s that it’s not possible to predict economic outcomes using those models, or any other models for that matter.