Fed's Latest Worry: Inflation 😳
But Another Powell Pivot May Come Before Too Long
The Federal Open Market Committee that Jerome Powell chairs made a major pronouncement last September 18. “The Committee has gained greater confidence that inflation is moving sustainably toward 2 percent, and judges that the risks to achieving its employment and inflation goals are roughly in balance,” the statement said. The FOMC was justifying a 50 basis point reduction in the policy rate, the first such huge cut since panic-ridden policy easing at the inception of covid.
Compare the September 18 statement with the minutes released Wednesday of the FOMC discussions at its January 28 - 29 meeting. “Participants generally pointed to upside risks to the inflation outlook,” the minutes said. “In particular, participants cited the possible effects of potential changes in trade and immigration policy, the potential for geopolitical developments to disrupt supply chains, or stronger-than-expected household spending.”
Has the economic outlook changed materially in four months to justify the shift in FOMC policy orientation and its reluctance to keep cutting rates further?
Not really. Rather, there may be other factors at work.
In contrast to the latest FOMC statement, Chairman Powell had stressed repeatedly at his press conferences that he would not speculate about the Trump trade policies and their impact on US inflation. Although the President has announced import tariffs against a range of countries and a variety of products since assuming office on January 20, none of the levies are final and may be canceled or reduced in response to concessions those countries may make. Why then is the Powell-led Committee using the potential inflationary impact of tariff and immigration policies to justify the latest pause in rate cuts?
The jumbo rate cut of September 18 took place just a few weeks before the November 5 presidential elections. There was no love lost between the Chairman and the then-Republican candidate. Powell surely remembers the severe public criticisms of his measures by Trump in the months before the November 2020 elections, and it is understandable that he would not want to endure that again by enabling a second Trump administration. Of course, it would have been impolitic to mention that as the reason for the policy switch implied in the latest FOMC statement.
The pickup in recent monthly inflation figures should not come as a surprise to SriKonomics readers. The acceleration in prices comes with average hourly earnings rising at a robust 4.1% annual rate, and the unemployment rate falling from 4.2% in November to 4.1% in December and 4% last month — a strong labor market by any measure. If they had studied US monetary history from the 1970s, FOMC members would have learned that inflation remains stubborn at low levels, and even turns upward, if additional monetary stimulus is seen to be forthcoming.
The decision to delay rate reductions does not necessarily mean that Fed policy is turning restrictive. Buried in the latest FOMC minutes is an indication that the central bank is getting ready to slow, or even end, Quantitative Tightening. QT has been the process by which the Fed’s balance sheet was reduced every month by taking back liquidity from some of the maturing Treasurys and mortgage-backed securities.
The latest Fed concern inducing the move to slow or end QT is that the ongoing discussion in Washington, DC on increasing the Treasury’s debt limit could end up causing a liquidity crisis for some banks. In turn, that would force a Fed intervention and bailout of financial institutions. Rather than continue the fight against inflation by selling assets, the Fed may be getting ready to provide a liquidity boost. Anti-inflation policies can wait!
Now, for some history. The Fed balance sheet, which was about $800 billion at the time of the failure of Lehman Brothers in September 2008, quintupled to $4 trillion at the inception of covid in early 2020. In late-2008, then-Fed Chairman Ben Bernanke termed the increase in assets held by the central bank as “temporary” and essential to counter the impact of the Global Financial Crisis. The stock market surged starting in 2009 while low-income and retired individuals were left to get near-zero returns from bank deposits. No problem for policymakers at the Bernanke Fed who simply pointed to the economic recovery and stock market rise as signs of success.
Rather than end the “temporary” measures, the Fed more than doubled the balance sheet to almost $9 trillion by early 2022. After resuming QT in June 2022, the central bank has already reversed policy once and flooded the market with liquidity after the regional banking crisis of March 2023. With QT resuming after the Fed had resolved the banking crisis with more liquidity, the balance sheet today of $6.8 trillion is 70% higher than it was in March 2020.
Expect the next policy easing to come, not through a reduction in the Federal Funds rate, but by ending Quantitative Tightening and possibly resuming Quantitative Easing. And investors have recognized the likely impact of higher Trump tariffs combined with a Federal Reserve that lacks a laser focus on lowering inflation. Yesterday, the University of Michigan released its survey of consumers’ long-term inflation expectations. They expect prices to rise at a 3.5% annual rate over the next five to ten years, the highest figure in the survey since 1995, according to Bloomberg.
Are you surprised that the combination of investor fear of the possible impact on economic growth of the new tariffs and rising inflation expectations led to sharp declines in major equity indexes to close out the week?
Dr. Komal Sri-Kumar
President, Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
February 22, 2025
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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