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Fed Chairman Powell Attacks the Core of Persistent Inflation

Economics is a social science; as such, it deals with human behavior. While economists are best known for reviewing statistics and plotting data points, those stats and chart plots all represent behavioral trends. Federal Reserve Chair Jay Powell is an economist that understands human behavior; that’s why he is resolved to get inflation back down to “acceptable levels” quickly. He knows what happens if higher price trends remain in place for too long.

The Fed Chair had been guiding the markets and businesses to expect a 50bp increase following the last FOMC meeting. When an inflation report a few days earlier indicated no lessening of the upward price trend, he became comfortable that moving 75bp instead of 50bp would not be going too far.

Federal Reserve officials have indicated they accept the risks of tightening to the point of causing a recession. This is because they are determined to prevent something they view as more difficult to treat. A prolonged upward spiral in prices would change consumer thinking and expectation. An expectation of ever-increasing prices could become self-fulfilling. Higher inflation at times is caused by expectations that prices and wages are going up, not by other underlying dynamics.

Inflation was part of the mindset of anyone who lived through the 1970s, increased costs were expected, and it was prepared for. Since the 1990s, when technology advanced at a rate where we became conditioned to wait for prices to come down, the risk of deflation had been the greater concern. Not today, a number of factors, including fiscal and monetary reactions to the pandemic, sanctions against Russia, and supply chain disruptions, have ignited inflation over the past year. Should it last long enough to become “the new normal,” it will be far more difficult to extinguish.

Powell said that people still expect inflation to come down in the medium and long run. He also said, the longer it takes to restore price stability, the greater the risk that those future expectations could rise. If that happens, he indicated, the U.S. could shift to a high-inflation regime. That could force the Fed to raise interest rates to even higher levels to break the stronger binds.

“We have high inflation running now for more than a year,” Powell said. “It would be bad risk management to just assume that those long-term inflation expectations will remain anchored indefinitely in the face of persistently high inflation. So we’re not doing that.” He asked, “Is there a risk that we would go too far? Certainly, there’s a risk, but I wouldn’t agree that’s the biggest risk to the economy.”

 

Take Away

Chairman Powell said at a central banking forum in Portugal. “The biggest mistake to make…would be to fail to restore price stability.” Inflation rises when demand for goods and services exceeds what is available, the pandemic lockdowns created shortages. Prices also rise when there is too much money chasing those goods. Again, the reaction to the pandemic created another key ingredient. Powell has little control over the supply of goods, but he does have the ability to control the amount of money and the cost of that money. And he intends to make it tight.

His approach is to kill the “cancer” before it becomes pervasive – even if the effort knocks the patient for a painful but survivable loop. At the root of this approach is the fear that households and businesses will come to expect high inflation to persist, which then can cause it to continue. That scenario would require the Fed to increase rates even more. Instead, he thinks it best to rid the country of it ASAP.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.politico.com/newsletters/morning-money/2022/06/30/where-jay-powell-draws-the-line-00043362

https://www.postgrad.com/subjects/social_sciences/overview/

https://www.wsj.com/articles/why-consumers-inflation-psychology-is-stoking-anxiety-at-the-fed-11657013400

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As the Treasury Matures Billions in Federal Reserve Holdings High Rates Could Squeeze the U.S. Budget

Have you ever taken out a 0% introductory rate credit card, ran up a bunch of charges on the low intro rate, and then had it reset to normal. It can be difficult to even keep up with interest payments, let alone chip away at the principal. Well, this is the situation the U.S. Treasury may find itself in as the Fed tightens from 0% at the beginning of 2022 to 3.50%, 4.50%, perhaps even higher before they find the terminal level that provides their desired 2% inflation target.

The seldom looked at dynamic of higher interest rates is that the U.S. Treasury is a huge borrower and that every basis point (0.01%) adds up. At the same time, the price of everything it purchases to run the country is subject to the same inflation dynamics gripping the rest of the world.

Since February 2020, already elevated national debt levels grew from $17 trillion to $24 trillion. Of this increase, $3.3 trillion would wind up owned by the Federal Reserve as part of their experimental
monetary policy. The U.S. Treasury positions owned by the Fed ballooned from $2.5 trillion in February 2020 to $5.8
trillion. Now Fed Chairman Powell is looking to cash in hundreds of billions of this debt to the U.S. Treasury without buying new issue debt.

The costs associated with this extra interest expense to the Treasury, without any additional benefit to citizens, may be felt in the form of a tighter national budget as interest costs grow and crowd out less immediate expenses. And interest costs do need to remain a priority; even the hint of default could drop the U.S. Government bond rating from S&P, Moody’s, or Fitch rating services. This would be devastating to the country’s overall ability to provide what we have come to expect as the basics. And it is something U.S. Treasury Secretary Janet Yellen would certainly not want to happen during her tenure.

The Part Q.T. Plays

Quantitative tightening (Q.T.) never fully got traction after the quantitative easing (Q.E.) that was implemented to deal with the 2008 financial crisis. As a reaction to fears of what the novel coronavirus might do to economic activity, a more aggressive, in size and format, Q.E. was put to work. In May, the Fed announced plans to begin to mop up all the extra money in the economy from bond purchases as part of past Q.E. strategies.

The announced plan is to reduce its Treasury holdings by $330 billion by the end of the year and by $720 billion annually until its balance sheet shrinks to a size deemed stabilizing at an inflation rate consistent with economic health. The Department of Treasury needs to give the Federal Reserve the loaned money back.

The Treasury has had the benefit of rolling higher interest rate maturing debt into lower interest rate bonds. This allowed them to increase their debt dramatically while federal interest costs barely increased despite the $7 trillion increase in Treasury debt. Using the 0% introductory credit card rate analogy, if a consumer moves $5,000 in debt from a 16.99% credit card to a 0% card, they can pile on almost $4,000 more in additional debt and still have a lower minimum payment. When the rate rises, a voluntary pullback has to be made by the consumer, as the interest servicing becomes a large budget expense.

Over the last three fiscal years ending on Sept. 30, 2021, the national gross interest cost was $573 billion, $523 billion, and $562 billion. These days are gone. Short-term rates have risen 1.5% following the Fed’s 75-basis-point rate hike in May and two smaller increases earlier this year. By the end of 2022, additional rate increases are expected to bring total rate increases to 3%, according to the Federal Reserve’s official guidance. The Fed projects short-term rates averaging 3.4% in December with a bias toward increasing next year.

As this additional 3% works its way into the refinancing of maturing Treasuries, federal interest costs will compound. There are about $3.7 trillion in outstanding Treasury bills, maturing in less than a year. Over 12 months, a 3% increase in rates would add to near $111 billion in additional annual interest expense on this outstanding debt.

There are $2.4 trillion Treasury notes (USTN) maturing within a year (notes are ten years and shorter, bonds are ten years and longer otherwise, there is no difference). The weighted average interest rate on these notes is 1.3%, and the weighted average original maturity is 4.7 years. So, to make the math easy,  to replace it with a similar average maturity (current five-year Treasury note) the Treasury would incur a yield of about 2.91% (today’s five-year yield). And this is after a substantial rally last week. Rolling this maturing debt is expected to cost the Treasury near $85 billion in additional interest rate costs.

Total federal gross interest cost over the 12 months ending on May 31 was $666 billion. Looking at the above maturing Treasury debt over the next year, we can calculate the additional interest cost to be near $860 billion. This is a cost for which citizens receive nothing. By comparison, the Medicare system’s annual cost is $700 billion, and military spending over the past 12 months was $746 billion.

 

Take Away

There’s an item on the U.S. budget that will be skyrocketing. This is part of the price of fighting inflation. Paying the added cost could come from reduced spending (unlikely), increased taxes (not politically popular), or new debt (the usual solution).

The Federal Reserve’s plan to raise interest rates through Q.T. and raise overnight interest rate targets will bring the cost of government borrowing up. There are very few who will benefit from this.

One group that may are those that have been living on a fixed income and have depended on interest rate products like bonds, C.D.s, preferred stocks, and even dividend-paying common stocks for their income. This group has been on a tighter budget than they have expected for a long time, and some have given up hundreds of thousands in income since 2008. They are finally going to get paid again on their savings. Let’s all hope this serves as a kind of stimulus “check” for this large demographic that keeps the economy moving forward and providing opportunities.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://fiscaldata.treasury.gov/datasets/monthly-treasury-statement/summary-of-receipts-outlays-and-the-deficit-surplus-of-the-u-s-government

https://www.reuters.com/markets/us/poll-no-respite-fed-rate-hikes-this-year-chances-rising-four-50-bps-row-2022-06-10/

https://www.wsj.com/articles/high-interest-rates-will-crush-the-federal-budget-inflation-debt-spending-costs-recession-economy-11656535631?mod=hp_opin_pos_4#cxrecs_s

https://fiscaldata.treasury.gov/datasets/monthly-statement-public-debt/summary-of-treasury-securities-outstanding

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Michael Burry’s Recent Fed Tweet Has Implications for Most Investors

The Federal Reserve receives splashy headlines when they up the overnight lending rate that banks charge one another. But Federal Reserve Chair Jerome Powell had laid out a schedule for something that is arguably more significant than a Fed Funds adjusted target – the schedule massively and methodically shrinks the Fed’s balance
sheet. Michael Burry noticed that the Fed has quickly veered from its quantitative tightening plans. He took to Twitter to let those of us in the markets know about it. The information he shared in a Tweet is important
to investors of stocks, bonds, and even real estate. What did Michael Burry’s 36 words say, and what else do investors need to know? 

About Burry’s Tweet

The hedge-fund manager that became world-renowned after being portrayed in the movie “The Big Short,” compared the Federal Reserve’s unresolved, high level of economic stimulus to the difficulties of drug addiction. He tweeted: “Drugs are hard to kick. Fed was supposed to sell $30B Treasuries and $17.5B Mortgage-Backed Securities per month starting June 1. Q.T.” He continued, “During June, MBS holdings rose almost $3B. Treasury holdings fell less than $10B.”

Source: @BurryArchive (Twitter)

Burry’s tweet refers to the Fed’s plan to reduce U.S. Treasury holdings by $30 billion for the months of June, July, and August and by $17.5 billion in mortgage-backed securities during these same months. This would effectively pull $47.5 billion in cash from the U.S. economy and would cause the new issuance replacing (actually funding) this maturing debt to need to find new buyers. New buyers are attracted when Treasury auctions to replace the maturing debt reach a high enough interest rate bid to sell every last penny. The Fed’s guidance meant that, at least for Treasuries, $30 billion non-Fed dollars would need to be attracted at Treasury auctions.

Is It True?

The holdings of domestic securities by the Fed are reported each week on the New York Fed website. Using the last week in May, and the last week in June, it would seem the Fed has only reduced its holdings by $7,419,485,200 overall. This is a $40 billion miss from Fed guidance given as recently as May.

The math can be refined using the website by drilling down into the holdings more, but Michael Burry’s tweet asserts that they added $3 billion in MBS, and Treasury holdings are only down by $10 billion. The $7 billion roughly equates to netting the difference between the two SOMA holdings; this is the total difference between the Fed’s two statements, four weeks apart.

What Does it Mean for Investors?

If, as an investor, you determine your positions by connecting “economic dots,” and you’re told by the Fed that they are transparent and that this is what you can expect from us if nothing changes, you align your positions according. That’s a fairly substantial “dot.”  For Michael Burry,  there is nothing I can see on his company, Scion Capital Management’s,  most recent SEC
13-F filing that would indicate he specifically used the Fed’s guidance, however, this 13-F is from May 16.

Investors inclined to trade on money supply, or interest rates, may have taken positions based on the Fed’s advertised transparency and guidance for the few months forward. One could imagine a scenario where investors would see the Fed’s activity serving to steepen the yield curve. This could have caused investment in stocks of some banks. Banks with a substantial portion of their earnings made from lending would benefit from a curve where the longer rates increase faster than shorter rates. A natural result if the Fed followed its plan.

The promised decrease in mortgage-backed securities could cause some real estate investors to pull back substantially, or at least more than they would have if they had known the Fed would actually increase its position.

Michael Burry is best known for his ability to spot what to short and how to short it. The Fed guidance would indicate that rates on longer-term Treasuries would rise with the $30 billion per month reduced holdings by the Fed. This would mathematically drive prices down with each uptick in rates. The actual number for June was closer to $10 billion. Not only would this lack of Fed follow-through in June mess with investor positions, it leaves in question whether Powell will be equally cavalier about promised future reductions. The Fed laid out a schedule where it would increase its reductions beginning in September. Investors, presumably Michael  Burry among them, now don’t know what to think. 

Paul Hoffman

Managing Editor, Channelchek

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https://www.newyorkfed.org/markets/soma-holdings

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Image: PhotoMIX Company

What Will It Take to End Rampant Home-Price Inflation?

Real wages are falling, inflation is at a forty-year high, and the Atlanta Fed predicts we’ll find GDP (gross domestic product) growth at zero for the second quarter. Meanwhile, both the yield curve and money supply growth point to recession.

But when it comes to the latest data on home prices, there’s still no sign of any deflation or even moderation. For example, the latest Case-Shiller home price data shows home prices surged above 20 percent year over year in April, marking yet another month of historic highs in-home price growth. It’s now abundantly clear that a decade of easy money, followed by two years of covid-induced helicopter money, has pushed home price growth to levels that dwarf even the pre-2008 housing bubble. This continues to make housing less affordable for potential first-time home buyers and for renters. Unfortunately, the options for “doing something” are limited, and probably require a recession.

But in the meantime, those who are already lucky enough to be property owners continue to see some big gains. According to the latest Case-Shiller home price report, released Tuesday (June 28):

Source: Case Schiller Home Report

According to the index, year-over-year changes have exceeded 18 percent for each month since June 2021, a rate well in excess of the growth rates experienced during the housing bubble leading up to the financial crisis of 2008. This growth is also reflected in month-over-month growth, which has not fallen below 1 percent in twenty-one months. In other words, as of April, there was still no sign at all that price inflation and declining real wages were doing much to dampen demand for home purchases.

Image: Case Schiller

The reader may remember that price inflation began to surge well above the Fed’s target 2 percent rate as early as April 2021. Price inflation hit forty-year highs of more than 8 percent during early 2022. Moreover, April of this year was the thirteenth month in a row in which price inflation outpaced growth in average earnings.

Housing Is Less Affordable, But There Are Plenty of Buyers

People are getting poorer in real terms, so it’s not surprising that April data also shows historic imbalances between disposable income and home prices. As of April 2022, the Census Bureau’s estimate for the average sale price of new houses sold reached 10.3 times the size of disposable personal income per capita. The average home sale price has been more than nine times disposable income for the past six months of available data. In recent decades, home prices have only been this unaffordable in periods leading up to recessions and financial crises—i.e., 1980, 1991, and 2007. April’s home-price-to-income ratio is higher than in any other period in more than forty-five years.

Image: Case Schiller

One reason the April data showed no sign of declining home prices is that employment data—a lagging economic indicator—still showed a relatively strong job market. Although total nonfarm employment remained below 2019 precovid levels, job growth was strong enough to combine with monetary inflation and fuel big growth in prices—an ongoing trend. Moreover, as of April, mortgage rates had not yet climbed out of very-low-rate territory. The average thirty-year fixed rate did not even reach 5 percent until mid-April. This, combined with continued job growth, helped keep demand high. (As of mid-June, however, the average thirty-year fixed rate is 5.8 percent, a thirteen-year high.)

So What Will it Take Before We Begin to See Any Real Reductions in Home Prices?

Unfortunately, the only real way out is probably a recession. This is thanks to a mixture of the regime’s fiscal and monetary policies. After so many months of reckless monetary inflation fueling out-of-control demand, all that newly created money continues to chase relatively stagnant supply. Supply has been hobbled by lockdown-induced logistical bottlenecks, US sanctions on Russia, and rising energy prices due to the regime’s war on fossil fuels. Thus, consumers can’t benefit from the sort of supply-driven disinflationary forces that helped keep price inflation at manageable levels during many periods in the past. Now, we’re just left with surging demand fueled by new money, without the market freedom necessary to provide breathing room through supply growth.

Will the Fed Tighten Enough?

Fed chairman Jerome Powell denied at this month’s Federal Open Market Committee meeting that the Fed is trying to bring about a recession to rein in price growth. But whether or not that is the intent, even the Fed’s very mild tightening has already accelerated the US economy’s slide toward recession—or at least toward job losses. For instance, there is growing evidence of sporadic mass layoff events. JP Morgan announced last week “that it was laying off hundreds of employees due to rising mortgage rates amid a troubling housing market plagued by inflation.” Redfin last week announced layoffs for 470 workers. Hiring freezes and mass layoffs are a growing concern in Silicon Valley.

If the US is indeed headed toward job losses and recession, the danger now is of the Fed not backing off monetary inflation long enough and hard enough to actually allow the economy to clean out the malinvestments and bubbles created by the monetary inflation of the past decade. The danger of too-weak tightening has been evident before. For example, the Fed moderately reined in monetary inflation from 1972 to 1974. But these measures proved to be too little to really end the inflationary boom. Thus, malinvestment and price inflation piled up until the early 1980s, when more tightening finally brought inflation under control.

So the question now is this: Will the Fed pull its foot off the easy-money accelerator only long enough to get a few flat months in price inflation and then return to the same old inflationary stimulus policies? That could win a brief reprieve for first-time home buyers and renters in terms of housing prices. But more than a brief reprieve is greatly needed. Of course, what the Fed should do is completely sell off its portfolio and stop manipulating interest rates altogether. But failing that, it needs to at least allow interest rates to rise enough—and shrink its portfolio enough—to allow for some real modicum of “normalization” in the financial sector.

In any case, real deflation—both monetary inflation and price inflation—is necessary, and that can only be accomplished if the Fed can resist the temptation to keep doing what it’s been doing since 2008 with “nontraditional monetary policy” including quantitative easing, financial repression, and bubble creation.

About the Author: Ryan McMaken (@ryanmcmaken) is a senior editor at the Mises Institute. Ryan has a bachelor’s degree in economics and a master’s degree in public policy and international relations from the University of Colorado. He was a housing economist for the State of Colorado. He is the author of Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre.

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Debt Servicing Costs are Rising for the U.S. Treasury – What Does that Mean for Investors?

The U.S. Treasury will be spending far more to service the nation’s debt with the recent increase in interest rates. This rise in borrowing costs could put a damper on government spending in other areas that more directly fuel growth. Each month the Treasury rolls (refinances) a large amount of its maturing debt at current rates; in the case of most maturities, the interest rate is more than double the level from a year ago.

 

The Situation

Spending by the U.S. Gov’t on interest in the fiscal year that began in October 2021 adds up to about $310 billion through the end of May. This is a 30% increase from the same period a year earlier, using data from the Treasury Department. The federal deficit has actually shrunk somewhat within the year, and higher debt servicing costs in the form of interest rates are an increasing expenditure for the U.S. at a time when other federal spending has many competing priorities.

Interest rates (as measured by the USTN 10 yr. benchmark) declined from October 2018 (3.22%) up until July 2020 (0.53%). It has been trending higher since then and is now equal to the October 2018 level (3.20%).

Image: U.S. Treasury 10 Year note Yield (Yahoo Finance)

Economic Impact

Analysts say an increase in the cost of the federal government’s borrowing could pull from spending on anticipated initiatives and add to the overall U.S. debt servicing paid for by taxpayers. This burden is projected to reach its highest-ever levels as a share of the economy over the next decade, according to estimates from the nonpartisan Congressional Budget Office. “Rising interest costs simply grow our debt and increase the burden on the next generation, forcing them to pay more for our past than for our future,” said Michael Peterson, chief executive of the Peter G. Peterson Foundation, a nonpartisan group that advocates for deficit reduction.

Treasury yields have been held down by extraordinary purchases by the Federal Reserve. This was ramped up after the 2008 financial crisis and was revved up again in response to pandemic efforts. The cost, in part, from some of these stimulative actions, have caused inflation levels to be running well ahead of rates paid on bonds. The Fed has announced they would be letting their yield-controlling bond purchases roll-off at a  specified pace, which will cause rates along the curve to move higher. Less money in the system and Treasuries drifting toward a more natural market rate will shift the entire curve upward. This shift is anchored at the Fed Funds overnight rate, which the Fed more directly orchestrates. The Fed has signaled it expects to notch up rates more in the coming months.

Since March, the Fed has raised the overnight Fed funds rate three times from near zero to a range between 1.5% and 1.75%. Most projections are for overnight rates to reach 3% to 3.50% by year’s end. Farther out on the curve, the 10-year treasury peaked as high as 3.50% this month and is currently (June 29) priced to yield 3.17%. The 10-year note is used as the benchmark from which lenders spread 30-year mortgage levels.

Treasury officials have indicated a large part of the increase in the government’s debt service costs so far this fiscal year has been tied to U.S. Inflation-Indexed Securities (TIPS). But as outstanding, lower-yielding securities are matured and replaced with higher-paying issues, the average interest rate across government securities gets locked in at higher levels. This will be gradual but impact government costs for an entire generation.

The Numbers

The U.S. has about $30 trillion in total public debt outstanding. As of late March, about 29% of outstanding Treasury securities were set to mature in one year or less. That debt, when refinanced, would quickly raise interest rate costs.

The Congressional budget office (CBO) has projected that in 2022, federal spending on net interest costs would reach $399 billion, compared with $352 billion in 2021. The average yield on the 10-year note from January through December they projected to be 2.4%, up from 1.4% last year.

Interest costs are expected to increase in each fiscal year through 2032 and total roughly $8.1 trillion over the next decade, which was completed in early March when interest rate forecasts were lower than today.

A CBO rule of thumb for scenario analysis uses a parallel shift of the curve upward by 0.50% to equate to $19 billion in higher interest costs over the year. Taking the scenario analysis out into the future, if the full curve of interest rates were 0.5 percentage points higher each year between 2023 and 2032, borrowing costs would be $1.3 trillion higher throughout the period.

Impact on
the Fed

The Fed holds a massive amount of securities it obtains through implementing monetary policy. Paul H. Kupiec, a senior fellow at the American Enterprise Institute estimates that, between December 31, 2021, and the end of May 31, 2022, the Federal Reserve lost $540 billion in market value on its massive portfolio of investments in Treasury bonds and mortgage securities. To put the loss in perspective, $540 billion is equivalent to 60 percent of the value of the Federal Reserve System’s entire asset holdings on September 1, 2008, just prior to the onset of the financial crisis.

Take Away

Markets participants have been hopeful that spending on many of the nation’s initiatives would significantly increase. This would provide opportunities to invest in infrastructure revamping, advances in health care, reduced carbon emissions, and other items laid out in the administration’s, American Rescue Plan.

Rescuing the country from higher and higher prices may put a damper on some of these initiatives, as higher debt servicing will take up a growing part of the budget as rates rise.

On the positive side, fixed income investors will receive higher interest payments which could stimulate and provide additional opportunities in other areas of the economy.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.gao.gov/blog/larger-federal-deficits-higher-interests-rates-point-need-urgent-action

https://www.wsj.com/articles/u-s-paying-more-to-borrow-as-fed-raises-rates-inflation-stays-elevated-11656165602

https://www.washingtonpost.com/business/2022/06/27/fed-rate-rises-interest-national-debt/

https://www.marketwatch.com/story/feds-daly-sees-another-big-hike-in-interest-rates-in-the-fight-against-inflation-11656101975

https://fiscaldata.treasury.gov/datasets/debt-to-the-penny/debt-to-the-penny

https://mises.org/wire/who-owns-federal-reserve-losses-and-how-will-they-impact-monetary-policy

https://www.whitehouse.gov/omb/briefing-room/2022/03/28/fact-sheet-the-presidents-budget-for-fiscal-year-2023/

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Image: CNBC Squawk Box

Inflation Will Give Way to Deflation But it Will Take Some Time Says Cathie Wood

Cathie Wood thinks we’re in a recession and said she admittedly underestimated the severity of inflation. The hedge fund manager, known for her optimism and bullishness on innovative and disruptive technologies, spoke on CNBC’s Squawk Box this morning (June 28) and backed off her usual balls-to-the-walls approach to investing in tomorrow’s technology. In fact, it was shocking to see her usual style of pushing through adversity and unrelenting advice that “truth will win out,” succumb to relent.

Instead, The Founder, CEO, and CIO of ARK Invest, which has seen portfolios under management shrink this year by as much as 66%, backed off. She even outdid the current mainstream pessimism saying the U.S. is already in an economic downturn. And while she had recently pinpointed deflation as the greatest risk to economic growth, she told the CNBC host she underestimated the severity and persistence of inflationary pressures.

“We think we are in a recession,” Wood said. “We think a big problem out there is inventories… the increase of which I’ve never seen this large in my career. I’ve been around for 45 years,” were some of the comments from the Wall Street veteran who will be 67 in November. Wood blamed the hot and dogged inflation on supply problems and the geopolitical crisis. “We were wrong on one thing, and that was inflation being as sustained as it has been,” Wood said. “Supply chain … Can’t believe it’s taking more than two years and Russia’s invasion of Ukraine, of course, we couldn’t have seen that. Inflation has been a bigger problem, but it has set us up for deflation.”

Wood said consumers are feeling the rapid price increases. She pointed to the University of Michigan’s Survey of Consumers, which showed a reading of 50 in June, the lowest level ever.

The traditional definition of a recession is two consecutive quarters of negative GDP. The U.S. experienced a negative quarter during Q1, so a second-quarter would officially define the current period as “in a recession.”

Gross Domestic Product, 2nd Quarter 2022 (Advance Estimate) will be released on July 28 at 8:30 AM. This first look at second-quarter growth will be the morning after the end of the two-day FOMC meeting and the accompanying announcement on monetary policy.

Cathie Wood, who is widely followed, especially by technology investors, remarked that her clients are mostly sticking with her, and money flow is positive into her funds. She attributes some of it to investors seeking diversification in a down market. ARKK had more than $180 million in inflows in June. “We are dedicated completely to disruptive innovation. “Innovation solves problems,” Wood said. “I think the inflows are happening because our clients have been diversifying away from broad-based benchmarks like the Nasdaq 100.”

Cathie Wood was early to put bitcoin in her funds and held high-flying names like Tesla and Zoom before they were on the radar of others. Lately, she has been accused of being out of touch. Most of her funds are well defined, leaving the discretion for the CIO to names, not broader sectors. The ARK Invest CIO may have found her hands tied by prospectuses and may continue to be challenged with this. But her economic calls are all her own, and she has backed way off what up to this point could have been seen as cheerleading economic releases and keeping her fingers crossed.

Paul Hoffman

Managing Editor, Channelchek

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https://www.cnbc.com/video/2022/06/28/ark-invest-ceo-cathie-wood-says-u-s-is-already-in-a-recession.html?jwsource=cl

https://www.cnbc.com/2022/06/28/ark-invests-cathie-wood-says-the-us-is-already-in-a-recession.html

https://www.bea.gov/news/schedule

https://www.marketwatch.com/story/cathie-wood-warns-u-s-is-already-in-a-recession-11656424710

https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm

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Image: FOMC participants gather for a two-day meeting held on June 14-15, 2022. (Fed Reserve)

Will a Third Mandate be Added to the Fed’s Challenges?

The House of Representatives just passed a bill that would add to the Federal Reserve’s monetary policy mandates. Currently, the Fed’s dual mandate is to seek maximum employment and maintain stable prices. If H.R. 2543 passes the Senate, the Fed mandate would also include “exercise all duties and functions in a manner that fosters the elimination of disparities across racial and ethnic groups with respect to employment, income, wealth, and access to affordable credit.” 

With the current mandates, the central bank is thought to be able to act independently to achieve stable prices and maximum employment. However, the Federal Reserve is always accountable to Congress. As we saw in late June, The Fed Chair testifies and reports to Congress on how the Federal Reserve is managing policy. They can be quite critical at these hearings, and there is often significant disagreement about how the economy should be handled.

The House bill passed last week 215-207 with little media notice. But it deserves attention because it may add a new layer of difficulty in implementing monetary policy.

Among those in the House that voted the amendment down is Congresswoman Stephanie Murphy of Florida. In her statement, she wrote, “The Federal Reserve’s dual mandate for monetary policy is to pursue price stability and maximum employment. At a time when Americans are facing the highest rate of inflation in four decades, the Federal Reserve’s priority should be to combat inflation without causing undue harm to economic growth and employment. By giving the Fed a new mandate, the bill could divert the Fed from its main mission and therefore cause harm to the very people it seeks to help. Those who stand to benefit the most from successful Federal Reserve action—and to lose the most from unsuccessful Fed action—are working families, including communities of color, struggling to afford gas, groceries, and other necessities.”

Supporters of the effort look at the broader implications beyond monetary policy, “I was proud to support the Financial Services Committee’s legislation today and thank Chairwoman Waters for her leadership.  As we address inflation and work to bring costs down for American families and small businesses, Congress must ensure that Americans aren’t losing money as a result of discrimination in lending, ”  said House Majority Leader Steny Hoyer.

The White House, which does not always comment on legislation, has thrown its support behind the bill. “The Administration strongly supports efforts to promote equity for underserved communities and increase access to safe and affordable financial services, wealth, and economic opportunity for all

Americans.” Earlier this month the President met with the Fed Chairman Powell, promising not to interfere with Fed policy and leaving the Federal
reserve responsible for Fed policy and outcomes. The rare meeting between a Fed Open Market Committee (FOMC) chairman and a sitting President seemed to highlight the autonomy under which the Fed works to achieve its mandates. Biden openly told Powell prior to the closed-door meeting that addressing inflation was his “top priority” and added that his plan “starts with a simple proposition: respect the Fed.”

If passed by the Senate and signed into law H.R. 2543, would raise some challenges for the Federal Reserve. An example of the challenges could be that by stimulating to promote employment,  asset prices rise, which makes them less affordable; by not stimulating, employment can be lackluster.

We can see how the Fed is in a box now. If they fight inflation, they could weaken an economy to the point of causing a recession. If they don’t, inflation may continue to be a problem. If a third mandate is introduced, they would find themselves even further constrained by competing priorities. The Bill is now moving to the Senate. Sign up for Channelchek emails to stay updated on this and other important market-related information.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.warren.senate.gov/imo/media/doc/Final%20Federal%20Reserve%20Racial%20and%20Economic%20Equity%20Act%20One%20Pager2.pdf

https://www.federalreserve.gov/aboutthefed/files/the-fed-explained.pdf

https://www.wsj.com/articles/a-woke-mandate-for-the-federal-reserve-racial-equity-congress-house-joe-biden-11655659047

https://www.federalreserve.gov/faqs/why-is-it-important-to-separate-federal-reserve-monetary-policy-decisions-from-political-influence.htm

https://murphy.house.gov/news/documentsingle.aspx?DocumentID=2032

https://www.whitehouse.gov/wp-content/uploads/2022/06/HR-2543SAP.docx.pdf

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Image Credit: Frankieleon (Flickr)

US Household Saving Rate Vanishes, Credit Card Debt Soars

The United States consumption figure seems robust. A 0.9 percent rise in personal spending in April looks good on paper, especially considering the challenges that the economy faces. This apparently strong figure is supporting an average consensus estimate for the second-quarter gross domestic product (GDP) of 3 percent, according to Blue Chip Financial Forecasts.

However, the Atlanta Fed GDP nowcast for the second quarter stands at a very low 1.9 percent. If this is confirmed, the United States economy may have delivered no growth in the first half of 2022 after the decline in the first quarter, narrowly avoiding a technical recession.

The evidence of the slowdown is not just from temporary and external factors. Consumer and business confidence indicators present a less favorable environment than the expectations of an optimistic market consensus. According to the Focus Economics aggregate of estimates, the United States economy should grow a healthy 3.6 percent in 2022, helped by very strong third and fourth quarters, at 4.9 percent and 5.5 percent growth, respectively. The main driver of this surprisingly resilient trend is the unstoppable consumption estimates. However, there are important clouds on the horizon for the American consumer.

About the Author: Daniel Lacalle, PhD, economist and fund manager, is the author of the bestselling books Freedom or Equality (2020), Escape from the Central Bank Trap (2017), The Energy World Is Flat (2015), and  Life in the Financial Markets (2014). Daniel is also a professor of global economy at IE Business School in Madrid.

We cannot forget that consumer figures have been relatively solid, but at the same time, there has been a collapse in saving, with the personal saving rate falling from 8.7 percent in December to a fourteen-year low of only 4.4 percent in April.

The United States personal saving rate is now 3.3 percent below its prepandemic level, and in early May, the University of Michigan consumer confidence index fell from 65.2 to an eleven-year low of 59.1, deep into recessionary risk territory.

The plummeting saving rate is deeply concerning. It proves that consumers are suffering from elevated inflation as real wages remain in negative territory. From April 2021 to April 2022, seasonally adjusted real average hourly earnings decreased 2.3 percent, according to the Bureau of Labor Statistics.

Put these two figures together—real average earnings down 2.3 percent and the household saving rate almost halved. Families are struggling, wages are dissolved by inflation and savings are being wiped out. Consumer credit card debt is almost at all-time highs. Balances rose to $841 billion in the first three months of 2022, according to data from the Federal Reserve Bank of New York.

We cannot forget that consumer figures have been relatively solid, but at the same time, there has been a collapse in saving, with the personal saving rate falling from 8.7 percent in December to a fourteen-year low of only 4.4 percent in April.

The United States personal saving rate is now 3.3 percent below its prepandemic level, and in early May, the University of Michigan consumer confidence index fell from 65.2 to an eleven-year low of 59.1, deep into recessionary risk territory.

The plummeting saving rate is deeply concerning. It proves that consumers are suffering from elevated inflation as real wages remain in negative territory. From April 2021 to April 2022, seasonally adjusted real average hourly earnings decreased 2.3 percent, according to the Bureau of Labor Statistics.

Put these two figures together—real average earnings down 2.3 percent and the household saving rate almost halved. Families are struggling, wages are dissolved by inflation and savings are being wiped out. Consumer credit card debt is almost at all-time highs. Balances rose to $841 billion in the first three months of 2022, according to data from the Federal Reserve Bank of New York.

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Powell Caught Between Competing Political Agendas and Economic Reality

Twice a year, the head of the Federal Reserve goes before the Committee on Banking, Housing, and Urban Affairs, of the U.S. Senate. The Chair delivers prepared remarks and then answers questions from members of the attending committees. Over the years, the Fed has gone from tightly guarding monetary policy plans to being as transparent as possible. In either case, as the nation’s top economist, they know if they say one wrong word during questioning, there can be significant shifts in the markets, and changes in all-around confidence globally. It’s perilous, and the challenge is even greater as they are economists that understand their role at a very high level, but they are taking questions from politicians that may have other priorities.

Chair Powell spoke about the overall economy, monetary policy, inflation, recession, and the terminal rate, or the highest rate expected during this tightening cycle.  He was unequivocal in his resolve to bring down inflation. In his opening remarks he began with, “At the Fed, we understand the hardship high inflation is causing. We are strongly committed to bringing inflation back down, and we are moving expeditiously to do so. We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses. It is essential that we bring inflation down if we are to have a sustained period of strong labor market conditions that benefit all.”

The Federal Reserve Chair believes it is possible to effectively reel in inflaton without entering a recession, but it became clear through the question and answer session that he would allow a recession if that is the solution to the inflation battle.

Overall Economy

Inflation remains well above the Fed’s longer-run goal of a modest 2%. In the 12 months ending April 2022, Powell pointed out that inflation, as measured by the PCE deflator, rose 6.3 percent. He indicated he believes the pace has held and that consumer demand is strong. The supply problems he admitted have been larger and longer-lasting than expected. He also noted that price pressures have spread to a broad range of goods and services. The surge in crude oil prices and other commodities from Russia’s invasion of Ukraine is also boosting prices for fuel and is placing even greater upward pressure on inflation.

Additionally, new Covid-19-related lockdowns in China will add to global supply problems.  Powell pointed out that the U.S. is not alone in dealing with inflation,  prices also increased rapidly in many foreign economies.

He believes GDP measured growth which was negative over the first quarter has picked up during the second quarter. Consumption spending remains strong, and the job market is on firm ground. He said he sees signs of business fixed investment slowing, and activity in housing softening. These were not characterized as bad during his testimony as tempered demand can better match supply and lead to a sustainable balance.

The Fed takes particular comfort with strong labor markets, it gives them room to work. The unemployment rate is near a 50-year low, job vacancies are at historical highs, and hourly earnings are up. Labor demand is very strong, while labor supply remains subdued, with the labor force participation rate little changed since January.

Monetary Policy

The Fed’s monetary policy actions are guided by its mandate to promote maximum employment and stable prices in the U.S. economy. Fed Powell said in his prepared remarks, “My colleagues and I are acutely aware that high inflation imposes significant hardship, especially on those least able to meet the higher costs of essentials like food, housing, and transportation. We are highly attentive to the risks high inflation poses to both sides of our mandate, and we are strongly committed to returning inflation to our 2 percent objective.”

In orchestrating lower inflation The Fed chair said he expects further rate increases will be appropriate, and the pace of the increases will depend on incoming data and outlook. During the last FOMC meeting, the Fed hiked the overnight lending rate by .75%, this was higher than earlier Fed guidance, it is presumed that increasing inflation conditions drove the higher than foretold increase. It sounds as though Powell is warning that they will continue to do what’s appropriate when they feel it’s appropriate —  situations change.

“Setting appropriate monetary policy in this uncertain environment requires a recognition that the economy often evolves in unexpected ways. Inflation has obviously surprised to the upside over the past year, and further surprises could be in store. We, therefore, will need to be nimble in responding to incoming data and the evolving outlook. And we will strive to avoid adding uncertainty in what is already an extraordinarily challenging and uncertain time. We are highly attentive to inflation risks and determined to take the measures necessary to restore price stability. The American economy is very strong and well-positioned to handle tighter monetary policy,” Powell said in opening remarks.

 Inflation

The Federal Reserve Chair believes it is possible to effectively reel in inflation without entering a recession, but it became clear through the question and answer session that the Fed places inflation concerns and the impact on the economy, ahead of recession risks.

As part of the discussion, members of Congress, especially those with more conservative leanings, hammered the inflation issue, pointing to stimulus spending sanctioned by the White House, and energy decisions that have reduced supply. Conservative members of the Senate also criticized the Fed for delaying drastic action on curbing inflation.

Other members of Congress dwelled more on outside issues that have impacted inflation and asked whether interest rates could have an impact on the increasing price of food, and energy. “A Fed increase won’t bring down these prices,” said Sen. Elizabeth Warren. “And why? Because rate hikes won’t make Vladimir Putin turn his tanks around and leave Ukraine. Rate hikes won’t break up monopolies, rate hikes won’t straighten out the supply chain or speed up ships or stop a virus that is still causing lockdowns in some parts of the world.”

Powell doesn’t believe the economy has “seen the full effect” of Covid-19 lockdowns.

 Recession

Some members of Congress see a political advantage in faster monetary-policy tightening. For some, a more hawkish Fed up front could put out the fire sooner and reduce damage from inflation. This would likely mean an upfront recession. For those that can’t resist viewing any activity as political, the November mid-term elections may be won or lost on the pace of the economy and the rate of inflation. The party in power in both Congress and the White House would not benefit from rising rates and a weakening economy.

For Powell’s part, what is most telling is that he did not seem overly concerned about the risk of slower or negative economic growth. He continued to emphasize inflation, fighting the price increases, and doing everything possible to avoid prolonged weakness while prioritizing bringing inflation down to a 2% target.  

 Terminal Rate

At Wednesday’s testimony, Powell estimated the longer-run neutral rate for Fed funds should be about 2.5%. He also continued to emphasize that in his estimate it would be appropriate to raise rates to a restrictive level to curb inflation. There was some talk about the Taylor Rule, which is a theoretical formula that suggests the Fed should adjust overnight rates by an amount equivalent to the spread between measured inflation and the desired inflation rate (presumed to be 2%). To this, the Fed’s Chair indicated that economics is more of an art than science. The current situation according to Powell is unique and has its own dynamics that include the war in Ukraine supply issues, Covid-19 lockdown effects, and stock and bond markets that benefitted from injections to stimulate during the pandemic.

Paul Hoffman

Managing Editor, Channelchek

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https://www.federalreserve.gov/newsevents/testimony/powell20220622a.htm

https://youtu.be/ULTY9NVtLxw

www.investopedia.com/terms/t/taylorsrule.asp

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The FOMC’s Big Decision on Rates

The Federal Open Market Committee (FOMC) voted to raise overnight interest rates from a target of 0.75%-1.00%. to the new level of 1.50% – 1.75%. The monetary policy shift in bank lending rates was greater than originally telegraphed by the Fed, but in line with many Fed watchers’ expectations that were swayed after the CPI release last Thursday. The Wall Street Journal and many primary bond dealers increased their forecast on Monday of this week to a 75bp increase from 50bp (nearly double the target rate at the time). The early reaction from the US Treasury 10 year was to increase by 2 basis points to yield 3.43% after trading 8bp lower most of the day (2:15pm EST).

The statement accompanying the policy shift also included a discussion on U.S. economic growth being stronger in the second quarter compared to the first. The central bank said overall economic activity appears to have picked up after edging down in the first quarter. Also, job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures.

The release discussed inflation risk and shaped an understanding of the many places higher prices are coming from. The release stated, “The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The invasion and related events are creating additional upward pressure on inflation and are weighing on global economic activity. In addition, COVID-related lockdowns in China are likely to exacerbate supply chain disruptions.” It added, “The Committee is highly attentive to inflation risks.”

There was no change in quantitative tightening. It will follow the exact schedule outlined earlier. For Treasury securities, the cap of securities allowed to roll off the balance sheet will be set at $30 billion per month and, after three months, will increase to $60 billion per month. The decline in holdings of Treasury securities under this monthly cap will include Treasury coupon securities and, to the extent that coupon maturities are less than the monthly cap, Treasury bills.

For agency debt and agency mortgage-backed securities, the cap will initially be set at $17.5 billion per month beginning June 1, and after three months will increase to $35 billion each month.

Take-Away

Higher interest rates can weigh on stocks as companies that rely on borrowing may find their cost of capital has increased. The risk of inflation also weighs on the markets. Additionally, investors that would prefer the “known” result of investing in the bond market or other interest rate products may pull assets out of stocks if they are attracted by the fixed income alternative. Investor money leaving the stock market reduces demand.

The next FOMC meeting is also a two-day meeting that takes place July 26-27. If the pace of employment and overall economic activity is little changed, the Federal Reserve is expected to again raise interest rates.

Paul Hoffman

Managing Editor, Channelchek

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Five Things to Know About the Fed’s Interest Rate Increase and How it Will Affect You

The Federal Reserve is expected to raise interest rates for the third time this year, on June 15, 2022, as it seeks to counter inflation running at the fastest pace in over 40 years. The big question is how much it will lift rates. Before the latest consumer prices (CPI) report on June 10, most market watchers and economists expected a 0.5-percentage-point hike (50 basis points). But now, more are anticipating a 0.75-point increase – which would be the largest in nearly 30 years. The risk is that higher rates will push the economy into a recession, a fear aptly expressed by the recent plunge in the S&P 500 stock index, which is down over 20% from its peak in January, making it a “bear market.”

What does this all mean? Brian Blank, a finance scholar who studies how businesses adapt and handle economic downturns, was asked to explain what the Fed is trying to do, whether it can succeed and what it means for you. His thoughts and advice are packaged neatly in answers to five questions many people are asking.

 

1. What is the Fed Doing and Why?

The Federal Open Market Committee, the Fed’s policymaking arm, is currently pondering how much to raise its benchmark interest rate. The stakes for the U.S. economy, consumers and businesses are high.

In recent weeks, Fed Chair Jerome Powell has signaled that the U.S. central bank would likely increase the rate by 0.5 percentage point to a range of 1.25% to 1.5%. But markets and Wall Street economists are now anticipating a larger 0.75-point hike because the May consumer price data suggest inflation has been unexpectedly stubborn. Some Wall Street analysts suggest a 1-percentage-point hike is possible.

Since the latest consumer price index data came out on June 10, the prospect of a faster pace of rate hikes has led to financial markets plunging 5%. Investors worry the Fed may slow the economy too much in its fight to reduce inflation, which if left unchecked also poses serious problems for consumers and companies. A recent poll found that inflation is the biggest problem Americans believe the U.S. is facing right now.

 

2. What is the Fed Trying to Achieve?

The Federal Reserve has a dual mandate to maximize employment while keeping prices stable.

Often policymakers must prioritize one or the other. When the economy is weak, inflation is usually subdued and the Fed can focus on keeping rates down to stimulate investment and boost employment. When the economy is strong, unemployment is typically quite low, and that allows the Fed to focus on controlling inflation.

To do this, the Fed sets short-term interest rates, which in turn help it influence long-term rates. For example, when the Fed lifts its target short-term rate, that increases borrowing costs for banks, which in turn pass those higher costs on to consumers and businesses in the form of higher rates on long-term loans for houses and cars.

At the moment, the economy is quite strong, unemployment is

low, and the Fed is able to focus primarily on reducing inflation. The problem is, inflation is so high, at an annualized rate of 8.6%, that bringing it down may require the highest interest rates in decades, which could weaken the economy substantially.

And so the Fed is trying to execute a so-called soft landing.

 

3. What’s a ‘Soft Landing’ and is it Likely?

A soft landing refers to the way that the Fed is attempting to slow inflation – and therefore economic growth – without causing a recession.

In order to stabilize prices while not hurting employment, the Fed is expected to increase interest rates rapidly in the coming months – and it currently forecasts rates to be at least 1 percentage point higher by 2023. It has already lifted its benchmark rate twice this year by a total of 0.75 percentage point.

Historically, when the Fed has had to raise rates quickly, economic downturns have been difficult to avoid. Can it manage a soft landing this time? Powell has insisted that its policy tools have become more effective since its last inflation fight in the 1980s, making it possible this time to stick the landing. Many economists and other observers remain uncertain. And a recent survey of economists notes that many anticipate a recession beginning next year.

That said, the economy is still relatively strong, and I’d say the the odds of a recession beginning next year are still probably close to a coin flip.

 

4. Is there Any Way to Tell What the Fed Might do Next?

Each time the Federal Open Market Committee meets, it seeks to communicate what it plans to do in the future to help financial markets know what to expect so they aren’t taken by surprise.

One piece of guidance about the future that the committee provides is a series of dots, with each point representing a particular member’s expectation for interest rates at different points in time. This “dot plot” has previously indicated that the Fed will raise interest rates to 2% this year and 3% soon.

Given the inflation news since the last meeting, investors are now forecasting an even faster pace of rate hikes and expect the target rate to be over 3% by 2023. Long-term interest rates, such as U.S. Treasury yields and mortgage rates, already reflect these rapid changes.

And so investors and economists will be watching to see how the Fed’s dot plot changes after it announces its rates decision on June 15, which will determine how quickly committee members expect to lift interest rates in the coming months.

 

5. What Does this Mean for Consumers and the Economy?

Interest rates represent the cost of borrowing, so when the Fed raises the target rate, money becomes more expensive to borrow.

First, banks pay more to borrow money, but then they charge individuals and businesses more interest as well, which is why mortgage rates rise accordingly. This is one reason mortgage payments have been rising so rapidly in 2022, even as housing markets and prices start to slow down.

When interest rates are higher, fewer people can afford homes and fewer businesses can afford to invest in a new factory and hire more workers. As a result, higher interest rates can slow down the growth rate of the economy overall, while also curbing inflation.

And this isn’t an issue affecting just Americans. Higher interest rates in the U.S. can have similar impacts on the global economy, whether by driving up their borrowing costs or increasing the value of the dollar, which makes it more expensive to purchase U.S. goods.

But what it ultimately means for consumers and everyone else will depend on whether the pace of inflation slows as much and as quickly as the Fed has been forecasting.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It was written by and represents the research-based opinions of D. Brian Blank, Assistant Professor of Finance, Mississippi State University.

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The Fed May be Orchestrating for Both Rates and Stocks to Climb Following the FOMC Meeting

Fed Chair Jerome Powell is following in the footsteps of the two Fed heads that came before him. That is to say, he is very transparent about his future actions. The Fed hasn’t made a surprise move in over 20 years. Remarkably they have telegraphed most everything in advance. So it came as a surprise to see broker-dealer shops like Goldman Sachs and Jeffries say they expect the Fed to tighten by 75bp rather than the 50 bp that Powell reiterated just a week ago. Do they know something, or is this conversation part of orchestrating an orderly return to 2% inflation without roiling the stock market?

We all want the Fed to succeed. Annual consumer price increases of 6%-9% would put a lot of households in jeopardy. While the stock market is not a direct mandate of the Fed, a market decline of an additional 10% would place retirement portfolios and businesses in harm’s way hurting even more households.

Since the FOMC last met and raised rates 50bp on May 2^nd, Powell has consistently indicated that we should expect 50 basis points following the June meeting (June 15^th). In the last set of minutes and through public engagements of other Fed Governors, there are indications that some would prefer a more aggressive pace of tightening. I’ve been paying close attention to FOMC meeting outcomes since the end of Paul Volcker’s last term, this is what I know; the Fed Chair does not get outvoted by other members. And, this Fed Chair hasn’t ever acted to surprise the markets. There have been times when Powell could have moved sooner or more aggressively than previously stated, especially in the early days of the pandemic, but he has instead given lead time for the markets to adjust. He showed the same patience with tapering.

After new inflation data was released last Thursday in the form of a CPI report, a likely 75bp rather than 50bp hike is being reported on all the major financial outlets. This would not seem very likely, even if the FOMC members feel they are behind the curve. The reason is simple; they want the market to trust what the Fed tells them. However, the other tool the Fed uses to control markets and even interest rates is very strong. It’s referred to as jawboning.

A more likely outcome of tomorrow’s meeting is a 50bp rate move with a much firmer message. If the desired outcome is to apply the economic brakes more firmly, not scare the stock market, and keep to its word, the FOMC is more likely to go 50bp and talk about 75bp in the message and messages following the meeting.

Consider this, a 50bp move after the market now expects 75bp is likely to cause investors to rejoice. Perhaps even cause a substantial rally.  A more hawkish verbal stance going forward would cause the bond market to take heed and move up in yield, and the door would then be open to go 75bp in late July after the stock market already becomes accustomed to the idea. In fact, market participants would remember the rally after the June meeting and be less fearful of future tightening moves.

Is this just a fantasy? It’s another forecast to consider; in my experience, it makes more sense than anything else. It does imply the Fed may have intentionally let a 75bp expectation slip to accomplish a goal – it would not be the first time.

Paul Hoffman

Managing Editor, Channelchek

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Inflation at 40-Year High Pushes Fed to Get More Aggressive – the ‘Beveridge Curve’ Should Give it Courage to Act

Inflation surged at the fastest pace in over 40 years in May 2022, pushing the Federal Reserve toward a more aggressive pace of interest rate increases to slow it down. While there’s concern it could cause unemployment to spike, a little-known economics indicator suggests the Fed can do so without causing too much economic pain.

The Fed has already raised interest rates twice in recent months – including a half-point hike in early May – in an effort to tame inflation. Yet the consumer price index rose to an annualized rate of 8.6% from 8.3% in April, the Bureau of Labor Statistics reported on June 10. That’s above economic forecasts of 8.2% and the highest reading since December 1981, which is the tail end of the last time the U.S. economy wrestled with ferocious inflation.

In other words, the actions by the central bank so far don’t appear to have had much of an effect.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It was written by and represents the research-based opinions of Veronika Dolar, Assistant Professor of Economics, SUNY Old Westbury.

But lifting rates further could come at a cost. Economists fear that raising rates too fast and too steeply would likely put the brakes on economic growth, resulting in an economic recession and soaring unemployment. Yet as an economist who studies inflation, I believe there are several reasons the Fed can more fiercely fight inflation without worrying so much about unemployment.

Slow at the Switch

Economists and investors have been urging the Fed to get more aggressive for many weeks.

Their main argument is that soaring inflation is at least partly the fault of the Fed – and the federal government. U.S. policymakers pursued very aggressive stimulus programs to cushion the economy-pummeling effects of COVID-19. The roughly US$4.6 trillion in stimulus money eventually led to an increase in overall demand for goods and services, which drove up prices at the same time that supply chains were a mess.

Compounding matters, Russia’s invasion of Ukraine has caused a spike in oil and gas prices.

Meanwhile, the Fed has been accused of being slow to take policy actions that could have helped tamed inflation sooner. Even the 0.5 percentage point rate increase in May seems weak in retrospect.

Reasons for Caution

In the Fed’s defense, it has good reason to be cautious. The Fed has what is known as a dual mandate to not only keep inflation in check but to promote maximum employment.

The trouble is, actions intended to reduce inflation can cause unemployment to rise.

And so the Fed has been focused on executing a so-called soft landing, in which it raises interest rates enough to slow inflation but not so much it sends the economy into recession – which would likely result in fewer job vacancies and more Americans without work.

But I think the Fed now has two big reasons to throw its caution to the wind.

Introducing the ‘Beveridge Curve’

The first is what the latest inflation data tells us. Runaway inflation is terrible for an economy, and very painful for consumers, and so the Fed has no choice but to bring it down at whatever cost.

The other has to do with what is known as the Beveridge curve, a tool economists use to analyze the labor market and one increasingly being monitored by Fed Chair Jerome Powell and others.

The Beveridge curve looks at the statistical relationship between the level of unemployment and the number of open job vacancies. The idea behind this curve is pretty straightforward: When there are many unfilled vacancies, the labor market is extremely tight, and it is easy to find work, leading to an extremely low level of unemployment. On the other hand, in a slack market, the number of vacancies is low and it is more difficult to find jobs and the unemployment is high.

In May, there were 11.5 million job vacancies in the U.S. for 6 million unemployed people. This nearly 2-1 ratio is wildly high – the highest ever recorded. In contrast, before the pandemic, when the labor market was in very solid shape, there was one vacancy for every two unemployed people. The Beveridge curve uses rates, so it currently shows a 7.3% job opening rate over a 3.6% unemployment rate.

Historically, a drop in job openings – prompted by a slowing economy, for instance – corresponds with a rise in unemployment, and vice versa. But the pandemic has changed the existing pattern dramatically, and it looks as if unemployment is less responsive to changes in the job opening rate. This means the Fed could get more aggressive about hiking interest rates to curb inflation without worrying so much that a drop in job vacancies due to an economic slowdown will cause unemployment to jump dramatically.

That said, we should also keep in mind that the latest numbers represent a lagging indicator. It takes time for the Fed’s policies to be seen in the data, and for all we know the rate hikes are already having an effect.

Still, I believe the Fed has a strong case for more aggressive action – so don’t be surprised if the U.S. central bank lifts rates by 0.75 percentage point at its next meeting in mid-June. That would be the biggest increase since 1994.

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