By now, all METARs have heard that the CPI rose to 8.6%, a 40-year record, last week. And it’s sticky.
The Federal Reserve is being blamed despite the fact that inflation was controlled despite years of ZIRP.
**If You Must Point Fingers on Inflation, Here’s Where to Point Them**
**By Christopher Leonard, The New York Times, June 11, 2022**
**The true culprit for high consumer price inflation is the Federal Reserve. The financial earthquakes of 2022 trace their origin to underground pressures the Fed has been steadily creating for a over a decade.**
**It started back in 2010, when the Fed embarked on the unprecedented and experimental path of using its power to create money as a primary engine of American economic growth.**
[Actually, it began in 2002 when the Fed cut the fed funds rate long after the mild 2001 recession was over, which led to the housing bubble. They just repeated that in 2009 (which led to the stock and bond market bubbles) and 2020 in a more extreme way. – W]
**To put it simply, the Fed created years of super-easy money, with short-term interest rates held near zero while it pumped trillions of dollars into the banking system. One way to understand the scale of these programs is to measure the size of the Fed’s balance sheet. The balance sheet was about $900 billion in mid-2008, before the financial market crash. It rose to $4.5 trillion in 2015 and is just short of $9 trillion today.**
**All of this easy money had a distinct impact on our financial system — it incentivized investors to push their money into ever riskier bets. A sobering realization is now unfolding on Wall Street. The decade of super-easy money is likely over. Because of inflation’s impact, the Fed likely won’t be able to turn on the money spigots at will if asset prices collapse. This is the driving force behind falling stock prices, and why the end of the collapse is probably not yet in sight. ...** [end quote]
The focus of this article is correctly on asset prices. The impact of the Fed’s monetary pumping was on asset prices since the money was pushed into the hands of banks, not consumers. Nobody was complaining about asset price inflation since everyone loved seeing the value of their assets rise. The Fed’s monetary pumping was truly gigantic. The Fed has bought $9 Trillion in Treasury and mortgage bonds in a $24 Trillion economy.
Consumer price inflation didn’t spike until the government sent extra money to consumers (sparking demand) at the same time that supply was constrained for many reasons. Government fiscal stimulus was breathtaking. The spikes in this chart are driven by the 2020 and 2021 stimulus payments to consumers. A lot of this was saved but those savings have been spent by now, since the current level of personal savings is below 4Q2019.
Some METARs will contest the reasons for consumer price inflation – but it really doesn’t matter at this point. I won’t argue about it because the arguments are tinged with politics.
As investors, we have to ask: What will happen in the markets?
The markets will be driven by Federal Reserve decisions on the only tools they have: the short-term fed funds rate and the interest rates of longer-duration Treasury and mortgages, which they can influence by selling some of their immense book of bonds. And the data shows that interest rates do drive asset prices, but have little direct effect on consumer demand. So far, the Fed has mostly been jawboning (“forward guidance”) and the markets have responded.
**Sizzling Prices Complicate Fed’s Inflation-Fighting Strategy**
**Central bank has used communications ahead of its policy meetings this year to influence borrowing costs**
**By Nick Timiraos, The Wall Street Journal, June 12, 2022**
**Fed officials said in recent weeks they were likely to follow an anticipated half-point rate rise this coming week with another one in July. But that was before Friday’s reports, which were worse than what officials had expected...**
**Changes made to speed or slow down the economy with interest rates take time to filter into borrowing and spending decisions. The economist Milton Friedman described these changes as the “long and variable lags” of monetary policy. ...** [end quote]
Everyone expects a 0.5% fed funds rate increase this week so the markets won’t respond. They will respond to the “dot plot” of forecast fed funds rates which captures the opinions of the different Fed board members.
The New York Fed’s April 2022 Survey of Consumer Expectations shows that inflation expectations fell to 6.3 percent at the one-year horizon and rose to 3.9 percent at the three-year horizon. This is concerning because it shows that inflation expectations are becoming “entrenched.”
In the 1970s, entrenched inflation expectations led to a wage-price spiral of increasing inflation. So the Fed is in a tight corner. If they don’t raise rates high enough to quench consumer demand (which will probably cause a recession) they will have 1970s redux and end up being forced to emulate Paul Volcker with extremely high rates and a nasty recession. This is a zugzwang where any move the Fed makes will cause problems, but they are forced to move or inflation will get worse.
As investors, we need to be aware that Fed moves will take a short time to damage our portfolios but a long time to improve the economic problem of consumer price inflation. Stagflation is the likely scenario, as described by the World Bank’s report.
The Control Panel shows foreboding by the markets.
The Treasury yield curve continued to rise. The 2YT gapped up to 3%. <gasp!> That shows the bond market is finally beginning to grasp that a neutral rate, which the Fed is seeking, is still far away.
The Fear & Greed index is in Fear. The market is risk-off, as stocks and junk bonds are falling in value even faster than the 10YT. The USD, oil and natgas are rising.
The METAR for next week is for bad weather, but I don’t see a crisis forming at this point. VIX is moderate and financial stress is very low. The market is far from a bottom since we are moving into “winter” and the season has had just a few months to develop. There will be more bad weather ahead. Much more.