Inflation figures for May published Friday left Biden administration officials with few positive factors to reference. Federal Reserve Chairman Jerome Powell who had long maintained that inflationary forces were “transitory,” and Treasury Secretary Janet Yellen who had repeatedly suggested that more fiscal spending would be better, were missing from the public talk circuit. Also notably absent was National Economic Director Brian Deese who had suggested that high inflation was not worrisome because it was backward-looking, being largely attributable to elevated energy prices.
The reason for the administration’s silence was the surge in prices that the US Bureau of Labor Statistics figures indicated. Consumer prices rose by 8.6% in May compared with May 2021, posting the fastest annual increase since December 1981. The increase during the month was a full percent from April 2022. The Fed’s and administration’s favorite step of stripping out food and energy from the calculation did not produce encouraging results either. The core index increased by 0.6% month-on-month in May, matching the rise in April. “Food at home,” a key item for low- and middle-income wage earners, rose by 1.4% in May, accelerating from 1% in April. Rent, accounting for about a third of the CPI basket, rose sharply as well.
When Powell holds his press conference on Wednesday after the decision by the Federal Open Markets Committee on interest rates, expect him to focus not on the CPI but on the Personal Consumption Expenditure deflator which has been rising at a slower rate. Another ploy is to emphasize the core PCE index whose rise has been slower still.
However, as Kelly Evans of CNBC pointed out in her note after the BLS report was released, the CPI is the appropriate measure to use because it is most commonly used to index various benefits such as Social Security payments. And, I would add, go for the headline number, not the core — residents do not live in a world where they can ignore the prices of fuel and food!
The Fed and the Treasury were probably rattled, but not surprised, by the market reaction. The Dow Jones Industrial Average and the S&P 500 index fell by almost 3% while NASDAQ — most sensitive equity average to higher interest rates — dropped by more than 3.5%. The yield on 10-year Treasurys surged 16 basis points to 3.16%, getting near the recent intra-day high of 3.2%. I continue to expect the 10-year yield to keep rising, topping out at 3.5% during the weeks to come.
Just as important, the 25bp surge in yield on 2-year Treasurys on Friday flattened the yield curve, putting the 2 - 10 yield spread at just 10bp by the end of the day. I shall repeat a position that I have stated in public — the yield curve is likely to invert again as it did in early April. Repeated inversions increase the likelihood of a recession, and were a hallmark of 2006 that heralded the start of the Great Recession in December 2007.
The FOMC meets on June 14 and 15 to decide on its next steps. Despite the new 40-year high inflation rate, I expect the central bank to increase rates by only 50 basis points — a tightening similar to what the Fed had signaled before the latest inflation figures were released. The decision will probably be to continue tightening by reducing the balance sheet by $47.5 billion during the month, a pace substantially slower than the $120 billion per month by which the Fed increased the balance sheet in the months following March 2020.
Simply put, while the Fed has two mandates — economic growth and prices — it is likely to show that it cares more about the growth / stock market objective than the inflation target. It cares more about easing than about tightening. The inflation objective is likely to fall by the wayside notwithstanding the latest inflation data.
Instead, what should the Federal Reserve do to meet its neglected objective? For perhaps the first time in his 4 1/2 years as Chairman, Powell needs to show that he cares sufficiently about the inflation mandate to do more than make pious statements that he cares about the pain consumers are experiencing. That would call for a switch from the standard policy since the 2008 financial crisis by three different Chairs of putting the wellbeing of equity holders above the rest of the economy.
For starters, raise the Federal Funds rate, currently at a range of 0.75 - 1%, by a full percentage point to 1.75 - 2%. And reduce the balance sheet by $100 billion per month, still slower than the pace at which it was increased during covid.
Will the moves not cause equities to crash and long-dated Treasury yields to surge? Would the resulting impact on housing, an important component of the US economy, not be negative? Will employment not be adversely affected? The answers are Yes, Yes and Yes. That would be the cost of Powell and Yellen repeatedly misjudging the pace of inflation and following easy policies. They can blame themselves rather than extraneous factors such as covid and the Russia - Ukraine war.
Once the pain of stagflation is contained, will Powell be able to effect an economic recovery during the remaining 3 1/2 years of his term? A lot of soul-searching to do by President Joe Biden who renominated him last November, and the Senate which confirmed him overwhelmingly last month.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
June 11, 2022
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.
This publication is for information purposes only. Past performance is no guarantee of future results. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. Any opinions expressed are current only as of the time made and are subject to change without notice. Sri-Kumar Global Strategies, Inc. assumes no duty to update any such statements. Any holdings of a particular company or security discussed herein are under periodic review by the author and are subject to change at any time, without notice. This report may include estimates, projections and other "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. This publication is not to be used or considered as an offer to sell, or a solicitation to an offer to buy, any security. Nothing contained herein should be considered a recommendation or advice to purchase or sell any security. Sri-Kumar Global Strategies, Inc., or its employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time without notice. ©Copyright 2022 -- Sri-Kumar Global Strategies, Inc., 312 Arizona Avenue, Santa Monica, California 90401; Telephone: +1-310-455-6071