“If you get to the mid-3s or maybe even a little bit higher, and then you stay there…,” Goldman’s Jan Hatzius mused, while chatting with Bloomberg TV on Tuesday about the prospects for the terminal rate and, more immediately, the likely tone of Jerome Powell’s remarks at Jackson Hole later this week.
I’ll confess to harboring more than a little cognitive dissonance at this point. There’s a sense in which the Fed has to (must) lean in, even if everyday people’s outlook for price growth is informed almost entirely by factors beyond monetary policy’s control.
Inflation isn’t just “too high,” as Hatzius put it. And it’s not just “much, much too high,” as Powell is fond of describing it. It’s unacceptably high such that anyone who was previously unapprised of the yawning disparity between the current pace of price growth and the Fed’s target, would judge policymakers irredeemably derelict upon being made aware of the conjuncture illustrated in the figure (below).
Main Street knows a lot about inflation. They’re the ones who can’t afford it. But they don’t know a lot about monetary policy, or how it works, which is a good thing because if they did, they’d know it doesn’t — work, I mean. Or at least not for them.
Inflation expectations have come down recently, but Fed hikes have very little, if anything, to do with those declines. It’s all about gas prices, which could just as easily go back up as they could continue lower. I’ve said this repeatedly, and I’ll say it again here: The Fed can’t afford to become just another discredited American institution. People can lose faith in the legislature. People can lose faith in the executive. People can lose faith in the courts. People can even lose faith in local governments’ capacity to deliver basic services like clean water. What can’t be allowed to happen, though, under any circumstances, is for people to lose faith in the money. If that happens, it’s all over.
Public faith in the Bank of England recently turned negative for the first time (figure below). There’s scant evidence to suggest the BoE could’ve done anything preemptively to blunt what’s now double-digit inflation in the UK. But, as the bank remarked earlier this month, while hiking rates for a sixth consecutive meeting despite predicting a five-quarter recession starting later this year, “It’s our job to get inflation back down to 2%. So we have raised interest rates.”
Although I’m (reasonably) sure the bank wasn’t attempting to deliver a dry lament for their own hopeless plight (the quote mentioned above came from a summary page which typically employs a more colloquial cadence), they might’ve been. Everyone on Main Street can see that when push comes to absolute shove, the path of inflation in developed economies depends on the path of commodity prices. Something else everyone on Main Street would tell you, if prompted, is that if too much demand is a problem, it won’t be for long. According to Asda, one of the UK’s “big four” grocery chains, people under 30 now have just £150 left over each week after paying for rent, food, transportation and essential bills. That marks a “huge” (Asda’s word) drop from last year. Almost 90% of the store’s shoppers are worried about energy prices.
Rate hikes are going to make the situation far, far worse. And they won’t do anything to stop energy prices from rising further. Yet, the BoE bears sole responsibility for inflation. The only tool they have for combatting it is Bank Rate and a bunch of gilts they can sell. “So we have raised interest rates,” as they put it.
One analyst recently described the UK as a borderline emerging market, sans a currency crisis. The reason for the BoE’s negative approval rating has everything to do with the way the question is posed. Specifically, it asks respondents to assess the way the bank is “doing its job to set interest rates to control inflation.” It doesn’t ask whether interest rates are even capable of controlling inflation in the first place. It implicitly assumes they are. That assumption is thus foisted upon the public, which is dangerous because in the event inflation spirals out of control, Main Street will start to think the people who have the capacity to help (ostensibly central banks) aren’t doing their job. In fact, there’s not much they can do in certain circumstances. Other than make people even more miserable by hiking rates. That’s a recipe for a crisis of confidence which could, in a worst-case scenario, result in a currency crisis.
Of course, a currency crisis isn’t likely in the US. It’s not clear how such a thing would unfold given that the number of preferable fiat currency alternatives to the US dollar is exactly zero. The point here is that central banks are set up for failure currently. If the public is apprised of their job description, and not apprised of the extent to which that job can be impossible depending on the nature of the inflation impulse, public opinion could turn against the money as a referendum on the people who control it. Given that possibility, it’s imperative that policymakers at least look like they’re trying. Hence my steadfast contention that Powell needs to lean in harder.
This is where I struggle with acute cognitive dissonance. Flash PMIs released on Tuesday showed services sector activity in the US slowed dramatically early this month. The services print was a god awful 44.1 (figure below). To call that a miss would be to… well, to miss the point. The lowest estimate was 48.5. It was a debacle.
The preliminary read on the manufacturing gauge was better, but last I checked, the US is still a services-based economy. The composite print, at 45, was the lowest since May of 2020, when most of the country was still under lock and key.
Leaning any further into this risks a deep downturn, especially considering no one has any idea what the lagged impact of 225bps of Fed hikes delivered over just a handful of meetings will ultimately be. The US hadn’t seen a 75bps rate hike at a single meeting since 1994. The Fed just delivered two of them in a row.
When it comes to public confidence, a deep recession probably isn’t as deleterious as runaway inflation, but that really depends on who you ask and what you mean by “runaway.” True runaway inflation (say, 50%) in the US would almost surely result in street protests, but as some readers have been keen to point out this year, such an outcome is a straw man. Or at least we all pray it is.
It’s possible, though, that Vladimir Putin isn’t done with the West — that he’ll endeavor to exact an ever higher economic toll commensurate with that exacted from Russia in retaliation for the Kremlin’s “special operation” in Ukraine. What happens if the “sticky” US inflation most analysts now expect for 2023 is accompanied not by falling commodity prices, but instead by additional acute commodity supply shocks? What happens if inflation in the US goes to 15%? Does the Fed just keep hiking? If so, to where? Until fed funds overtakes headline CPI? Surely not, right?
I don’t know. And hopefully it’s not something we’ll have to confront. But as you parse the daily policy banter and assess the merits of various arguments for a more assertive Powell (and, again, I’ve been adamant in making that argument myself), it’s worth at least acknowledging that there is a limit. Inflation isn’t “everywhere and always a monetary phenomenon,” and as we’re already seeing in the UK (and as we’re about to see in Europe), demand destruction alone isn’t sufficient to bring down inflation as long as people still need energy and food. German electricity prices, discussed here last week and again on Monday, are now the equivalent of $1,000/barrel of oil. Read that again. If European power prices were crude oil, they’d be $1,000 per barrel.
One evening, in 2040, a father and his two young children gather around a small fire next to their ramshackle cabin in the woods. As they roast what little they were able to find to eat that day, one of the children asks, “Tell us again what happened in 2023. Tell us again how it all went wrong.” “Well, son, everything just kept getting more expensive,” the father will say. “So, we raised interest rates.”
What happens if the “sticky” US inflation most analysts now expect for 2023 is accompanied not by falling commodity prices, but instead by additional acute commodity supply shocks? What happens if inflation in the US goes to 15%? Does the Fed just keep hiking? If so, to where? Until fed funds overtakes headline CPI? Surely not, right?
Luckily the US enjoys having the worlds reserve currency, would be interesting to see what the choices would be otherwise,
maybe have to pull an “Ergodan”
Go back and read what Volcker did. Check the rate and inflation charts. The answer was yes.
There is no doubt in my mind that recession, even a deep one, is preferable to runaway inflation. Recession will depress irrationally exuberant asset prices (home, stocks, crypto, PE) and cost many millions a job — temporarily, we can only hope. Runaway inflation will lead to widespread social unrest and maybe the end of American democracy.
The end of American democracy is already here thanks to gerrymandered districts. If you want to read something truly disconcerting, the linked article (below) is among the most frightening pieces I’ve read in a long time. And don’t make the same mistake I did — namely, read the title, assume you already know the story and click away. It took me a week to find my way back to it because I just assumed it was another run-of-the-mill lament for unfairly redrawn electoral maps. It’s much more than that. Unless you’re already an expert on Ohio state politics, it’ll still shock you no matter how much you know about gerrymandering…
https://www.newyorker.com/magazine/2022/08/15/state-legislatures-are-torching-democracy
I saw that article. I would not go so far as to say gerrymandered districts in red states are the end of democracy. The simple reality is that state houses are an important part of the American political playing field, which democrats have largely ignored for 20 years. As a result, democrats have definitely played a role in facilitating the end of democracy. But American democracy is not dead yet.
Since Lincoln the US has seen an ebb and flow of success for different parties in different areas of the country. But after the year 2000, where before they had always dwelled and vigorously supported party candidates, the Democratic Party decided that spending money in red states wasn’t worthwhile. In effect, they substantially ran away from red statehouses in the late 90s and early 2000s. They outright focused on national office and ceded statehouses to the republicans.
Alongside the rise of red states, democrats were cowed by Gingrich and the so-called “freedom caucus.” They did not know how to confront Gingrich’s rhetoric. I still don’t believe the abundance of democrats know how to use rhetoric on media platforms. But it’s at the state level where they need (desperately at this point) to develop their rhetoric and assert themselves for the good of their state and country.
American politics, government by the people and for the people, is about being engaged. If the Democratic Party does not invest in all red states and make effective arguments with “Mr. and Mrs. Jones” in places like Ohio, which today is definitely a red state, then we are indeed more likely to meet the fate you expressed, the demise of our democracy. It would also be helpful if they learned how to use the media. The party needs to confront the reality.
An unsettling read. Thanks.
The Economist magazine I read yesterday had a two page look at how the GOP in the US is being pulled away from their traditional financial and ideological partners in the business community. After reading that I turned to a partner and said ” this country is f5@&=k going forward.”
Your commentary builds on that unease.
Thanks to an imbeded hatred of anything “socialist” in this country, the outcome is likely to resemble Bolsonaro’s Brazil or Peron’s Argentina. We once laughed at those stupid nations ….
The real issue is 2024 assuming a trump 2 or desantis 1 term. As for rates, well you won’t have to wait too long for lower rates, but be careful what you wish for….
Losing faith in the Fed is not losing de facto losing faith in currency. As pointed out, most people don’t know what the Fed does, but they sure know the function of the dollar.
If the Fed can’t control inflation why do they exist? Full employment! Oh wait, nope, not that either. Maybe we’ll collectively wake up to the lie and move closer to jettisoning the institution that stands most in the way of economic mobility, both up and down.
H-Man, the New Yorker article on Ohio gerrymandering was more than scary. I assumed the judicial system would come to the rescue and was even more shocked to see a federal court basically overrule the Ohio State Supreme court to permit patently illegal redistricting.
I must assume when you are thinking about relocating, Ohio is not going to be on the list.
As for Powell and the Fed…they need to be “the Adults in the Room,” …for now that means Powell being steadily and convincingly hawkish this Friday, then raising rates btw50-75 bps next month depending on tightness or looseness of financial conditions, then sooner rather than later (assuming markets finally accepting reality) declaring a pause to allow economic trends and rate hikes to play out with reevaluations at subsequent meetings. This also tacitly acknowledges the limitations of fiscal policy given current extenuating circumstances…
As for the US I’ve stated before that the 2000 election where the Supreme Court 5-4 overruled Florida’s right to count their votes started the decline of the American empire. Trump’s ascendancy in 2016 put the decline on steroids, and we may be too far gone already.
We’re left with hope and very little else.
I’m already too depressed to read the piece on Ohio, but having a hypocritical and religiously motivated Supreme Court that rules mask mandates as government overreach yet forced pregnancies not pretty much takes the cake for me, and of course we were all warned by Trump in his 3rd debate where he said he would appoint SC justices who will overturn Roe.
GLTA…
The only way to reduce gerrymandering, and simultaneously save democracy in the US, is to enact term limits and reduce the amount of money available to politicians, thereby make being a politician less financially lucrative – either legally or illegally. Our current system is not attracting the type of public servants that we want and need.
Frightening article, indeed.