Poor Jerome Powell! Within a week of his testimony before the Senate Banking Committee that we are “not far” from getting the confidence to start cutting interest rates, new inflation data released by the US Bureau of Labor Statistics on Tuesday (here) and Thursday (here) undercut him. It must be a painful lesson for the Federal Reserve to realize that basing monetary policy on causa falsa can be counterproductive.
The headline Consumer Price Index rose by 3.2% in the year ending February, accelerating from 3.1% in January. So much for the excuse that start-of-the-year peculiarities with January data were behind that disappointing data-point. The acceleration of the month-on-month increase from 0.3% to 0.4% last month also provided little cover for the central bank.
There was no relief in the monthly change in the core CPI measure either. Excluding food and energy, consumer prices rose by 0.4% last month, the same pace as in January. And even though the annual change in core CPI slowed from 3.9% to 3.8%, the latest figure was above market expectations.
The Producer Price Index for February released Thursday showed that the month-on-month rise had doubled from 0.3% in January to 0.6%. The 1.6% increase during the twelve months ending February was the fastest increase since September. The PPI increase is particularly troubling because it is often seen as the forerunner of CPI changes.
I was not surprised by the upturn in inflation, and you would not be either, if you have been a regular SriKonomics reader. While the Biden administration blames price gouging for the continuation of above-target inflation, and criticizes “shrinkflation” as a hidden factor, neither development would have been viable in the absence of massive fiscal and monetary goodies provided since the inception of covid.
As the fiscal faucet gets turned on further between now and the November 5 elections, expect the upward pressure on prices to be maintained. As for monetary measures, what is Powell likely to do? He has told us repeatedly that he will not comment on fiscal policy deeming it to be a prerogative of the US Treasury. He also showed us during 2020 - 2021 that he would ignore a hugely expansionary fiscal policy and provide concomitant easing measures of near-zero interest rates and a doubling of the Fed balance sheet. Unless Powell learned something from the not-so-transitory inflation experience of 2021 and 2022, his Fed will likely continue to implement interest rate and balance sheet policies without paying heed to the extent of fiscal stimulus there is in the system.
What does that mean for interest rates? At the long-end, yields on 10- and 30-year Treasurys have moved up significantly this week. I continue to believe, however, that 10-year securities are likely to top out in the neighborhood of 4.25%, and the 30-year at around 4.40%. Why? Anything significantly higher would “break” the system, becoming its own corrective device. Yield on two-year Treasurys, that reflect market perception of future Fed policy, surged by 21 basis points this week, from 4.53% at the start to 4.74% last night. This should disappoint those who expect the first rate to occur soon.
On the policy front, having doubted from the start the prevailing consensus that successful inflation mitigation would allow the first rate cut to occur in March, I now do not expect easing to occur in June either if the move were to be based on progress in achieving the Fed’s target. If anything, from an inflation point of view, the pressure should be on the Fed to hike rates as its next move. That is assuming we have a disciplined, as well as apolitical, Federal Reserve.
You will not be surprised to learn that I do not believe such an entity exists! Instead, failing to meet its inflation mandate, expect the Fed to switch to saving the system, euphemistically called “maintaining systemic stability.” The fear of more bank failures, or the fallout from the ballooning Commercial Real Estate loan repayments due in 2024 and 2025, are the kinds of developments that could precipitate emergency rate cuts and a resumption of Quantitative Easing.
Think back to 2008. Fed Chairman Ben Bernanke had suggested that the subprime mortgage issue would be merely a $50 billion - $100 billion problem. He responded to the immensity of the Global Financial Crisis with zero rates and a “temporary “ QE program, unleashing the excesses that we have been paying for since.
Jerome Powell may be set to follow that example.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
srikumar@srikumarglobal.com
@SriKGlobal
March 16, 2024
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What a mess!