Listen to the Fed
The Credit Strategist Blog
Fed Chairman Jay Powell told the Senate Banking Committee this morning what markets don’t want to hear: “[I]nflation has moderated somewhat since the middle of last year but remains well above the FOMC’s longer-run objective of 2 percent…That said, there is little sign of disinflation thus far in the category of core services excluding housing, which accounts for more than half of core consumer expenditures.” He continued: “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes…The historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”
One year into this tightening cycle, inflation remains well above the 2% target. Any thought that the Fed is going to lower rates in 2023 is a dead issue at this point (barring a exogenous shock). Markets, which have been extraordinarily slow to adjust to the fact they are operating in a 5% rather than a 0% rate environment, moved sharply this morning on Powell’s words, jumping terminal rate expectations to 5.6% (we’ll see if they stay there). At this point, the possibility of a terminal rate closer to 6% than 5% is rising uncomfortably. Six percent rates would be extremely problematic for the highly leveraged American economy. But employment and other data on which the Fed relies to set policy are not deteriorating as quickly as expected for complex reasons having to do with the hangover from massive pandemic stimulus and other factors. As a result, the Fed is finding it more difficult than many pundits expected to lower inflation. Then again, that’s why they’re pundits (Hence the expression, “Those who can, do. Those who can’t, pontificate.”)
The causes of inflation may be hiding in plain sight. Government spending is out-of-control. And there is no sign it will stop. With trillion dollar deficits soon to turn into two-trillion dollar deficits, higher inflation is baked into the economy as far as the eye can see.