I’ve said it before, and I’ll say it again: In my opinion, it’s not ideal for one reporter to hold sway over the US Treasury market.
I’m referring, of course, to Wall Street Journal “Fed whisperer” Nick Timiraos.
As a general rule, I eschew the temptation to document his tweets in real-time or to amplify his articles, which many rates traders view as Fed smoke signals.
There’s a strong case to be made that the Fed over-communicates already, and whether or not there’s any truth to the idea that Timiraos is a conduit for Fed messaging, the fact that markets think he is just adds one more voice to the policy cacophony.
For whatever it’s worth (and to both the US rates complex and equities, it appeared to be worth something), Timiraos expressed an interest on Tuesday in a Cleveland Fed research piece published more than a month ago. In essence, the authors argued that getting inflation back to target in the US may require a doubling of the unemployment rate and a “deep recession.”
The researchers, Randal Verbrugge and Saeed Zaman, suggested the December SEP — which posited PCE inflation running at 2.1% by year-end 2025, and the jobless rate rising a mere nine-tenths to 4.6% this year — was implausible. There’s no use troubling readers with the specifics of the models. The work builds on Powell’s “three buckets” description of inflation from the December press conference (i.e., goods, housing services and non-housing core services). If you’re interested, the full paper is here.
What matters (or, more to the point, what stuck out to Timiraos, who posted a link to the paper on social media) is the authors’ contention that the SEP is inconsistent. “Our model projects that conditional on the SEP unemployment rate path and a rapid deceleration of core goods prices, core PCE inflation moderates to only 2.75% by the end of 2025. Inflation will be higher for longer,” they said, adding that, “A deep recession would be necessary to achieve the SEP’s projected inflation path.” Here’s the longer quote and the key chart:
Rather than core PCE inflation reaching 2.1% by the end of 2025, our model projects that it will be at 2.8%, with the 70% confidence interval spanning 2.4% to 3.2%. A key to this result is the fact that inflation is more persistent than commonly believed. We conclude that it would take a deep recession to reduce inflation faster.
We investigate the claim of former Treasury Secretary Lawrence Summers (reported in Aldrick, 2022) and the supporting assessment of Ball, Leigh and Mishra (2022) that it will require two years of 7.5% unemployment from its current low level of 3.6% to 3.7% to bring inflation down to its 2% target. We find that one year of 7.4% unemployment would accomplish this task.
In a mild recession scenario (which the authors define as “roughly” consistent with 2001), inflation would be 2.4% by 2025. In a soft landing, inflation would remain “a touch above” 2.8% in two and a half years’ time.
As a reminder, the unemployment rate ticked lower to just 3.4% in January, according to a jobs report which some market observers said might’ve been distorted by weather and statistical anomalies.
“Considering the current unemployment rate matches 70-year lows, it would appear we have a long way to go,” JonesTrading’s Mike O’Rourke dryly remarked, of the paper and Timiraos’s decision to highlight the research.
Of course, 7.4% unemployment is suboptimal unless the only thing you care about is an arbitrary inflation target. Indeed, the authors suggest pursuing the severe recession route isn’t necessarily the best path.
They did, however, add a caveat to their welfare analysis: It “abstracts from any danger of the un-anchoring of inflation expectations that might be associated with core PCE inflation still being nearly 2.7% three years from now.”
If we assume Timiraos is highlighting this at the FED’s behest, it could be an opening salvo in eventually re-striking the inflation target higher. I suppose it serves a dual purpose of saying, “Hey we warned you,” in the event that there IS a deep recession.
It’s ironic to me that the Fed tried in vain for years to raise the level of inflation to 2% and now all of a sudden we’ve hit (whatever it is now) and at least some Fed analysts have proclaimed that inflation is stubbornly high and can’t be brought in line without unemployment of 7.4% or some such nonsense. No matter from which direction the Fed approaches its goal, it can’t seem to get there. There must be some sort of force field around 2% protecting it from harm.
cue Alanis Morissette lyrics
I think the idea that the Fed is preparing to increase its inflation target is investor wishful thinking.
For the Fed to target inflation at 3% or 4% would be a very big policy change, with major economic consequences. To do so when it is struggling with high inflation would badly damage the Fed’s credibility and perceived power. Powell would risk going down in history as something worse than Burns – a bitter disappointment for a man who measures himself against Vockler. Whatever the future costs of inflation, they will be blamed squarely on the 2023 Fed and none of the FOMC members will escape the taint.
Why would the Fed take that step? Unemployment is low, consumers are spending, corporate profit margins are historically high, house prices are ditto, spreads are low, where is the financial distress and economic pain? Yes, the Fed governors and economists are somewhat worried about long/variable lagging into a recession, but so what? Recessions are routine, part of the normal business cycle. No, the Fed is not particularly worried about investors’ portfolios. A) that’s not their problem, B) bear markets are routine, and C) where’s the bear market?
The Fed is not going to blow up its mandate and credibility just to appease angsty, whingeing investors who haven’t even lost that much money.
I remember someone saying “Wars are inflationary” and the land war in Europe isn’t over.
No point in moving your (inflationary) goal posts if the “black swan” event hasn’t finished yet… much like China finally ending zero covid with a bang (that markets mostly ignored), it ain’t over till it’s over.