The outcome of the Fed’s next meeting will, for all intents and purposes and assuming no additional bank failures, be decided this Wednesday. Or at least that’s the boilerplate copy.
Economists expect to hear that core CPI in the US rose 0.4% in March from February, while the headline gauge is seen posting a more pedestrian 0.2% increase.
If this were a strictly “data dependent” Fed, it’s hard to understand how a consensus CPI report could possibly be construed as supportive of ending the hiking cycle. And, as discussed here Friday, given where we are in that cycle, a pause is tantamount to the last hike. Given market pricing and concerns around the impact both of legacy tightening and last month’s bank theatrics, a pause and then a resumption of hikes later this year would be highly disruptive.
But, again, a Fed that’s actually being guided by the incoming data couldn’t plausibly suggest it makes sense to pause with core CPI at 5.6% (consensus for March) and the MoM readings at 0.4%. That isn’t consistent with a return to price stability as (arbitrarily) defined by the Fed. Assuming an in-line report, the YoY core print would be rising again.
At the risk of coming across as unduly obstinate, there’s not a lot of disinflation going on here. Core CPI is higher now than it was in December of 2021, when Jerome Powell decided to jettison the “transitory” charade. While the MoM pace is slower, it’s not nearly slow enough.
There’s a sense in which the bank failures were a godsend for the Fed. At least now, if they decide to pause, they have something superficially plausible to cite. Prior to SVB’s collapse, Powell was leaning entirely on a tenuous thesis that said goods prices wouldn’t accelerate anew, housing disinflation was “in the pipeline” (don’t tell prices in the South) and services ex-housing, while showing no improvement yet, would eventually start to moderate. I can sum up that thesis in one word: Hope.
With the banking sector problems, the Fed can at least argue that credit contraction will work alongside the lagged impact of last year’s rate hikes, and that risks around CRE (for example) are now greater, although Powell’s been reluctant to concede there’s any risk in CRE at all. (“Subprime is contained.”)
I think we’re compelled at this point to admit the obvious: The Fed is going to pause rate hikes without convincing evidence that core inflation is on a sustainable path back to target. Whether that pause comes in May or June doesn’t really matter in that context. They’re going to hope that core inflation eventually settles somewhere between 3.5% and 4% and they’re going to tell the public that 2% is achievable later. If that turns out to be a lie, it’ll be ok (they hope) because by the time it’s apparent, consumers will have acquiesced to the new reality and won’t care anymore.
That’s the backup plan. Forgive me, but it almost surely is. It’s certainly not what anyone wants, but the bottom isn’t just going to fall out for core services inflation with the unemployment rate between 3.5% and 4.5% and wage growth in the same range. Unemployment was near 11% in 1982. It was 9.5% in the summer of 2009. It’s laughably far-fetched to believe the US is going to get from 6.5% core inflation back down to 2%-2.5% with a maximum unemployment rate of 4.5%.
I’ll concede that the odds of a soft landing have perhaps improved, and also that it’s entirely possible a lot of the labor market normalization burden can be shouldered by a reduction in job openings. But given labor agitation (where you can take “agitation” to mean both churn and literal agitation, as workers are restless and agitating for better pay and benefits), I think it’s reasonable to suggest that pressure on employers will remain intense for the foreseeable future. If workers insist on meaningfully positive real wage growth after decades of flat pay, that’s going to upset a lot of C-suite apple carts and sets the stage for a very contentious relationship between capital and labor, which is inflationary.
The only “hope” for the Fed assuming they do want to pivot (and given the geopolitical backdrop, I’m not sure that’s a safe assumption) appears to be that r-double-star is so much lower than r-star that “higher for longer” will eventually result in enough financial instability to trigger a shock of sufficient magnitude to scare consumers out of consuming, scare businesses out of hiring, scare workers out of their demands and give monetary policy enough air cover to pivot to rate cuts.
Maybe this’ll all work itself out later this year via some combination of tighter lending standards, “long and variable lags” and good geopolitical luck, but count me skeptical.
Do note that defense spending needs to rise going forward (for obvious reasons) and notwithstanding debt ceiling posturing from the House Freedom Caucus, populism (both left- and right-wing) is inflationary. Also, there’s a geostrategic motive for the Fed to keep rates “higher for longer.” And we’re just one more supply chain or energy shock away from this entire effort going up in smoke.
One alternate reality that still isn’t anyone’s base case, but probably should be, is a kind of bifurcated regime wherein rates stay high, but the Fed perpetually deploys the balance sheet to put out fires, close bases and, if necessary, cap long-term borrowing costs for a government that wants to fund war outlays, domestic infrastructure and so on.
Consider all of the above just a collection of thoughts on the future of inflation and policy as we approach terminal.
In the new week, markets will hear from Barkin, Goolsbee, Harker, Kashkari and Williams. The March FOMC minutes, due just a few hours after CPI on Wednesday, will be parsed relentlessly given that last month’s hike was apparently an eleventh hour call in light of the banking stress.
Also on deck: NFIB, PPI, the preliminary read on University of Michigan sentiment for April and retail sales, which’ll give traders an update on the nominal spending impulse in March.
Isn’t hiking one more time and letting it ride sort of ideal? It seems like the economy can handle 5% rates if the Fed pauses and lets everyone acclimate, plus letting it run hot (maybe tepid) preserves the labor regime where wage gains are at least keeping up with inflation and possibly accretive if inflations settles under 5%. That kind of inflation would also help the federal government erode their debt burden, which I’d argue is the only way they’re capable of dealing with it. Obviously if CPI goes back to 9% that’s extremely awkward, but if possible this seems like a good place for the fed to be. I don’t really buy that they intend to get back to 2% – it seems more beneficial to let inflation hover above their target range and not blow up the labor market.
Thank you Mr. H.
You are stating clearly what is obvious to you and a good many of your readers.
Be careful out there.
Even the FED is trying not to fight the FED
I have been absent for some time and now am on my way out the door for a remote destination where i probably will not have service, but speaking of alternative realities: What are y’all think about Texas’ idea of creating their own gold backed digital currency?
I love this idea. Let’s see, they got their own power grid. This would add their own money. All they’d need is the bomb and their own army and we could just sever them from the system.
What are the current odds on “Texit,” which would probably be as favorable for them as the one across the pond.
At this point in time- almost all state/local governments have significantly underfunded pension plans.
The unfunded pension liability for Texas is equal to about $250B, which is 4 times the current annual budget for the state of Texas. No way any state would walk away from the federal government- who potentially may end up funding unfunded state/local governments pension liabilities.
https://www.federalreserve.gov/releases/z1/dataviz/pension/funding_status/chart/
Underfunded public pension plans seem like a slow burn sort of crisis, that first draws higher taxes and lower benefits before more drastic measures like enlisting the Federal govt to bail out CRE. Is there a reason to think this can won’t be kicked down the road for some years more? Abbott seems like the kind of guy who’d happily lay off public employees and raise their pension taxes.
Just so we don’t lose track here. Five percent basic rates don’t seem to be killing anyone yet, but five percent through the curve will require frequent rises in the debt ceiling or there won’t be much of a government left. And 3.5% inflation is OK by me. I’m old and I’ve got enough money to get by just fine. However, in ten years, say, 3.5% will still knock off 30% of the dollar’s purchasing power, compared to a loss of 18% with the target of 2.0% inflation. In the intermediate term, 3.5% is tolerable. But it will take away a bunch from those who can least afford it.
It’s killing the mid-size/small/regional banks. You have trillions of interest earning assets earning less (when operating/carrying cost are taken into consideration) than current Fed Funds. Banks currently are fine from a liquidity crisis perspective as long as depositors don’t panic. But bank earnings will be hit especially banks that predominantly rely on interest income. Mid/Small/Regional banks are heading into an earnings crisis. Regional bank equity will get crushed. We will see mass consolidation in the banking sector starting before the end of the year, maybe even this summer.
The question becomes how many of these banks fail prior to being bought out by a larger bank (likely a lot) and does it cause contagion to other parts of the economy (almost definitely).
Note this does not apply to Systematically Important Financial Institutions (SIFI) aka large banks. They are essentially quasi-subsidiaries of the Fed functioning as conglomerates with banking divisions.
In fact, we have a long way to go and there’s no hurry. I like the idea of a Fed that has at least one foot planted in reality. Would love a soft landing, but prefer a lasting sense of control on inflation. Sure, a pause will be nice if it’s based on evidence and reality. But the idea is to still economic impulses that may yield bad outcomes. If the governors have evidence that all will be well, then let’s pause. If they lack that conviction, impose a quarter point and take a wait and see attitude.
My thought process after reading the first paragraph:
…Wait, the next meeting isn’t until May.
…Won’t they have April’s inflation info then?
…Oh, I guess it won’t be out yet.
…But certainly there will be preliminary data they can look at.
…Of course all that information is kept secret until it’s released.
…I can understand the need for confidentiality. Maintain a level playing field and all.
…But still, isn’t it more important that the Fed have access to the most recent, up-to-date information to make the best decision possible?
And that’s when it hit me.
How sad is it that the Bureau of Labor Statistics is better at keeping secrets than the Department of Defense?
How about this for some inflation statistics! This is from a Bloomberg article that was recapped in a recent issue of “The Week”:
From 1970 to 2021, the median U.S. income increased 7.7 times, the median rent by 11 times, and the median home sales price by 18 times.
The fastest increases came in recent years, especially during the wild pandemic housing market.
From my own research- the S&P500 went up 203 times over that same time period (assuming you reinvested dividends).
Potentially, after the next FOMC meeting, the game score will be something like
– FF rate 5%
– CPI 5%
– UE 3.5%
– GDP trend 1.5%
That sniffs like stagflation-lite. At least, it doesn’t look like a win for Team Fed. Not even a draw.
Will Team Fed “want” to throw in the towel and walk off the field without a win?
If it doesn’t want to, what will “make” it head for the showers?
There may be a Big Breakage about to jump into the ring and K.O. Powell et al right through the ropes, but if the Fed doesn’t see it coming, I don’t think the mere possibility will force their hand.
I’m starting to like the idea of 1/8th point hikes after May,
Good article, knowing all this what is the investment strategy til year end?