Dovishness To Take A Hit

More Fed Officials Run From Powell's Rate Outlook

You read it in SriKonomics last week: “Traversing the final steps to achieve the inflation goal is the hardest.” Just four days later, release of the December consumer price numbers showed the first empirical support for this statement.

Despite most analysts anticipating continued improvement, inflation during the year 2023 came out at 3.4% compared with the 3.1% that the consensus had looked for. Even though core inflation (which excludes food and energy) decelerated from 4% in November to 3.9% in December, optimists had expected a larger drop. While core inflation, month-on-month, was unchanged from November at 0.3%, the headline inflation rate accelerated from 0.1% to 0.3% last month. Shelter-related costs contributed over 50% of the monthly increase, the US Bureau of Labor Statistics said.

The disappointing statistics had more Fed officials distancing themselves from hints by Chairman Jerome Powell on December 13 that the central bankers may be thinking of a rate cut as the next move. John Williams, President of the Federal Reserve Bank of New York, who had distanced himself from Powell’s dovish statement soon after Powell made it last month, repeated his words of caution on Wednesday. “It is important to stress that we still have a ways to go to get inflation back to the FOMC’s [Federal Open Market Committee’s] longer-run goal of 2 percent,” Williams said, providing no hint of quick, or several, rate cuts.

Two other Fed officials jumped on the cautionary bandwagon. Loretta Mester, head of the Cleveland Fed, told Bloomberg’s Michael McKee that the latest CPI report showed that there is still more work to be done in inflation mitigation. She bluntly stated that March would be too early to cut rates. Not to be left behind, Austen Goolsbee, President of the Chicago Fed, said Thursday that he was not the official who had forecast a Federal Funds rate of less than 4% by year-end 2024, and that he had been closer to the median.

Why are colleagues deserting Powell? Because his comments, despite being politically expedient as I surmised, do not find support in a historical context nor are they backed by economic theory. Having hoped fervently in 2021 that any upsurge in inflation would be “transitory,” the Chairman now wishes with similar intensity that he would be able to cut rates soon and frequently. Unfortunately, there is a gap between hope and reality!

If any of the geopolitical risks I have discussed in past analyses — an expansion in the Middle East conflict, a continuation of the Russia - Ukraine war, or an increase in China - Taiwan tensions following today’s Taiwan election results — come true, expect global and US inflationary pressures to increase. These plausible events would call for monetary policy to be conducted cautiously rather than be based on hope.

The concerns are not just fear mongering. US military led attacks on Houthi rebel sites in Yemen on Thursday and yesterday, and the rebels vow to retaliate. An estimated one-third of the global container trade goes through the Red Sea, and decisions by more shipping companies to avoid the region could cause the merchandise to take a circuitous route through the southern tip of Africa, contributing to higher cost and supply bottlenecks. In Taiwan, the pro-independence candidate William Lai has won, and the Biden administration is expected to send a delegation to meet with his team. China will not be pleased with either development!

What then, to make of the Producer Price Index numbers from yesterday, released by the BLS, the same entity that published the CPI numbers on Thursday? Headline PPI fell by 0.1%, the third consecutive monthly decline for the index. Delving below the headlines, the BLS report notes that around one-half of the fall in the goods component is traceable to a 12.4% decline at a monthly rate in the cost of diesel. The positive contribution of energy to the index could be reversed as a result of geopolitical tensions.

Despite the euphoria in markets yesterday that the PPI figures once again reinforce expectations of a March rate cut by the Fed, the central bank would be well advised to wait. Both the failure to detect inflation’s persistence during 2021 - 2022, as well as the Fed’s history of stop-and-go anti-inflation measures during the 1970’s, suggest that the central bank may not get another opportunity soon to regain credibility if its expectations are not met.

Rather than inflation coming down to the Fed’s 2% target, an easing could be the result of a “systemic” event. Banks — small, medium and large — bought 10-year Treasurys yielding between 1% and 1.5% during 2021 that will continue to be under water despite the rally in these securities since November. As in past occasions, the US central bank may have to explain any easing as designed to “save the system.”

Yes, expect interest rates as well as long-dated yields to be lower in the course of 2024, but do not expect that to be the result of the Fed’s success on the inflation front.

Dr. Komal Sri-Kumar

President

Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

January 13, 2024

Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities.  Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.

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