Stubborn Inflation: Does Fed Care?

Powell Needs a Much-Delayed Economics Lesson

As Federal Reserve Chairman Jerome Powell graduated from Princeton University in 1975 with a degree in politics, and went on to get a degree in Law from Georgetown, inflation was raging in the United States. Bullied by President Richard Nixon, then-Fed Chairman Arthur Burns followed a policy of increasing and decreasing interest rates, more in line with the requirements of the presidential election cycle than to the needs of the economy. Powell appears to have learned little from the disastrous results of that experience.

He has repeatedly insisted that he believes that it is time to switch attention from inflation to focus on the jobs front. That has meant, in the Fed’s collective thinking, that it is time to ease policy since inflation would eventually reach the 2% goal, while the economy and employment needed further assistance. He and his colleagues on the Federal Open Market Committee are discovering that last week’s data signal that inflation remains stubborn — more on this later — while data from consumer behavior and the labor sector provide no indication of a deteriorating economy.

Those of us who studied the inflation surge after 1973 resulting largely from the surge in monetary expansion at the beginning of that decade learned not to declare victory prematurely because prices tend to reaccelerate in the final stages. Powell appears to have missed that lesson.

After doing little to dissuade markets from expecting yet another rate cut next month, the Chairman became cautious in his speech at the Dallas Regional Chamber on Thursday — one of his many pivots over the past year in his efforts to provide “forward guidance”. “The economy is not sending any signals that we need to be in a hurry to lower rates,” he asserted. How then does he justify the massive 50 basis point reduction in the Federal Funds rate that he implemented when even a 25bp cut would have pleased investors? Why was that jumbo cut followed by another rate reduction this month? And now, all of a sudden, the Chairman has discovered that there is no urgency to cut rates?!

The shift in attitude was occasioned by the release by the Bureau of Labor Statistics of consumer price and producer price figures that suggested that the Fed story of inflation moving toward the 2% target was not working out. The headline consumer price index accelerated from 2.4% in September to 2.6% in October. Excluding food and energy, the core measure showed an increase of 3.3%, unchanged from September, and sitting at a three-month high.

A major contributor to CPI inflation was the rising cost of shelter (rent) as suggested in SriKonomics in July. Shelter cost increase jumped from 0.2% month-on-month in September to 0.4% in October, and the corresponding annual figure rose from 4.8% to 4.9%. The rapid increase in rents is unlikely to be reversed soon with the price of houses continuing to rise, and with home affordability worsening.

Signs of stubborn inflation were probably not the only factor causing the new sense of caution exhibited in the Powell speech in Dallas on Thursday. According to the US Census Bureau, retail sales rose by 0.4% in October, above consensus expectations. The figure for September was revised up sharply from a 0.4% rise to 0.8%. The strong sales growth suggests that US consumers are still on a spending spree — not great news for a Federal Reserve that has cut interest rates by 75bp in the past two months even as it purports to bringing inflation down. And the labor market does not indicate that it needs help from Powell and his colleagues. Initial jobless claims during the week ending November 9 dropped to 217,000, the lowest since May.

And after voting almost unanimously to cut the policy rate by 50bp in September, and unanimously to reduce by 25bp this month, Fed members’ publicly expressed views have already started showing signs of backtracking. Susan Collins, President of the Boston Fed, said that although the FOMC was considering another rate cut in December, it was not yet a “done deal”. Austan Goolsbee, President of the Chicago Fed, suggested on CNBC SquawkBox yesterday that the Fed would keep lowering the policy rate as long as inflation kept moving toward the 2% inflation target — not a particularly revealing comment.

How did the markets react to this week’s numbers suggesting lack of progress on inflation, and Chairman Powell’s speech? The various equity indexes started their decline as Powell gave his talk in the few minutes left before market close on Thursday, and continued to fall yesterday. Was he suggesting that the Powell Put was coming to an end?

Treasurys, on the other hand, were more prescient and had already voted on Fed measures starting in September. The yield on 10-year securities, which stood at 3.62% on September 16 closed last night at 4.44%, up 82bp in just two months. If there will be new indications suggesting that large scale imposition of trade tariffs is in prospect, or if the Trump administration actually implements a major deportation of undocumented aliens pushing up wage cost, expect Treasurys to react faster than equities in selling off.

Does the Fed understand all the interplay across various forces? It is far from clear. Powell and his colleagues may conclude that the lesson they should take away is that the surge in Treasury yields calls for another bout of Quantitative Easing to lower them rather than implement responsible policy. Such a policy would provide the put the market craves for but end up prolonging the crisis.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

November 16, 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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