Why the Fed Can’t Stop Inflation
Consensus opinion projected the Federal Reserve would elevate its target rate 75 basis points today.
The monetary authority greeted expectations, precisely — 75 basis points it was, announced at 2 p.m. Eastern.
Thus the federal funds rate presently ranges between 2.25–2.50%.
This rate of course falls miles and miles beneath the 9.1% (official) consumer price inflation currently going.
Assume today’s blazing inflation endures. Mr. Powell and mates will need to get much better water on the inferno.
This, they intend to accomplish. Today they muttered that they “anticipate that ongoing increases in the target range will be appropriate”… as inflation “remains elevated.”
Yet the stock market was up and away on the news…
Powell Gives the Market Hope
The Dow Jones closed the day 436 points higher than where it started the day.
The S&P 500 closed 102 points higher, while the Nasdaq Composite enjoyed itself a truly lovely spree — up a delirious 469 points on the day.
Why did the stock market react to today’s 75-basis-point hike with such bounce?
The Federal Reserve did telegraph additional hikes today, it is true. Yet they also hinted they may soon back off, that they may kink the hoses some.
Fire Chief Powell:
As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation… recent indicators of spending and production have softened.
There you have your explanation for today’s stock market extravagance — by our reckoning at least.
Bad News Is Good News Again
Affirms BlackRock’s Gargi Chaudhuri:
The reason this is providing some relief to the equity market is the Fed is acknowledging that there can be an impact on growth, to the economy, based on their policy. They’re recognizing there are two sides of this: There’s a growth trade-off to fight inflation. That recognition is something we had today that we didn’t hear before.
Adds Goldman strategist Christian Mueller-Glissmann:
The market has shifted to bad-news-is-good-news again, the whole idea that central banks will pivot because the data is so bad. We’re going back to a template that we know well.
We do know the template well — overly well.
But is the Federal Reserve throwing water on the wrong target?
It’s a Supply Problem, Not a Demand Problem
It is attempting to throttle demand. Yet as Jim Rickards has noted, today’s inflation owes primarily to supply chain delinkages, not overabundant demand — that is, to supply limitations.
The Federal Reserve can attempt to choke demand all it pleases. Yet it is incapable of mending the shattered supply chains.
It is akin to taking aspirin for a bellyache or penicillin for a broken jaw.
It is the wrong fix. So long as supply chains are discombobulated, inflation will run loose.
Rate increases will therefore fail to douse inflation’s flames.
They will likely, however, give a good soaking to the economy. The required gallons would overtake, inundate and drown the thing.
Toward a Hair-Curling Recession
Recession is a near inevitability. As our former colleague David Stockman styles it:
[What we’re seeing] is powerful inflationary momentum that will take years to vanquish… The only thing that can slow down the inflationary freight train, therefore, is gobsmacking three-digit rate increases capable of shutting down new borrowing completely, thereby materially draining demand from overheated domestic product and labor markets.
Today’s 0.75% elevation therefore fails Mr. Stockman’s rigid requirements. This noted Cassandra continues, wringing troubled hands:
That’s not about to happen, of course. Instead, what lies ahead is a tangle of start-and-stop anti-inflation maneuvers by the Fed that will only prolong the inflationary disaster now upon us, even as the latter is inexorably destined to end in a hair-curling recession.
Can the Federal Reserve attain rates much above 3% — perhaps 3.5% — without lethal economic consequences?
We are not half so convinced it can. We therefore believe 3–3.5% will represent high water. Levels will drop thereafter.
Incidentally — or not incidentally — the market believes the Federal Reserve will commence rate cuts in Q1 2023.
The Tractor Beam of Zero Rates
We believe the market gives an accurate forecast. We further believe the Federal Reserve will begin another merry chase toward zero.
“We’re probably never going to go away from zero rates,” concludes hedge fund grandee Kyle Bass.
The economy has already fallen within the inescapable “tractor beam” of zero rates:
As we have all learned, once an economy falls into the tractor beam of zero rates, it’s almost impossible to escape them… Growth numbers are going to come down and real growth might go to zero. We’re probably never going to go away from zero rates.
We fear this Bass fellow is correct.
Each instance the Federal Reserve attempts to “normalize” rates, it must abandon the hunt long before it nears its quarry.
The Great Millstones of Debt
Today’s debt levels are so monstrous they cannot endure appreciably higher rates. The burden would prove impossible, millstones hanging from the neck.
Compare today’s debt-to-GDP with 1970’s — when the Federal Reserve was still jailed in by the gold standard:
The Economy Can’t Breathe on Its Own
Like a man hooked to a respirator, the economy cannot breathe on its own. It is too dependent on central bank oxygen.
The Federal Reserve plugged in the oxygen during the Great Financial Crisis… and never took it out.
It attempted a weaning some years back but in late 2018 the market began to gasp and wheeze dreadfully.
To yank the oxygen now — after even greater respiratory support — is to commit a suffocation, a murder.
The Lost Opportunity
The economy might breathe freely today had Dr. Bernanke and his successors only let the economy recapture its own wind post-crisis.
The initial gasping might have been frightful, it is true.
Yet the market would have coughed out the excesses of the previous boom — and gradually filled its lungs with the invigorating oxygen of honest capitalism — of profit and loss, of creative destruction.
Alas, it was not to be. And so the economy remains on artificial ventilation, where it will likely remain until the end of the chapter, world without end.
We have likened Jerome Powell to the ancient Sisyphus of Greek mythology. The poor fellow kept pushing his boulder up the steep hill, only to have it roll back down with each attempt.
He can never summit the hill. Unfortunately, neither can the economy…