When inflation began to rise in 2021, Fed Chairman Jerome Powell said that it would be transitory and would even out the lower inflation in 2020. Nobel Prize winner and New York Times editorialist Paul Krugman agreed and called all the economists who agreed “Team Transitory.” Ex-Treasury Secretary Larry Summers disagreed and predicted high inflation, based on the record huge amount of fiscal and monetary stimulus.
https://data.bls.gov/timeseries/CUUR0000SA0L1E?output_view=p…
https://www.nytimes.com/live/2022/04/12/business/cpi-inflati…
**Consumer prices rose 8.5 percent in the year through March, reaching the fastest inflation rate since 1981. ... Stripping out volatile fuel and food, so-called core prices climbed at a brisk 6.5 percent in the year through March, up from 6.4 percent in the year through February. Even so, the core index offered a rare glimmer of good inflation news: It slowed down a bit on a monthly basis, rising 0.3 percent from February, compared with 0.5 percent the prior month. ...**
**A spate of recent developments could keep inflation uncomfortably high....Wages...housing costs...busnesses raising prices ...** [end quote]
When the inflation numbers came in hot, Paul Krugman admitted that “Team Transitory” had, um, made a mistake or maybe been premature. He’s still on “Team Transitory,” though.
https://www.nytimes.com/2022/04/12/opinion/inflation-consume…
**Inflation is About to Come Down — but Don’t Get Too Excited**
**By Paul Krugman, The New York Times, April 12, 2022**
**...**
**The Consumer Price Index — which roughly speaking measures average prices over the month — probably missed a downward turn that began in late March and is accelerating as you read this. Inflation will probably fall significantly over the next few months.**
**There are growing indications that the bullwhip is about to flick back...retailers appear to have overbought and are sitting on unusually large inventory. Car lots are filling up; demand for trucking is falling quickly....**
**But don’t get too excited. The better numbers we’re about to see won’t mean that the inflation problem is over....The U.S. economy still looks overheated. ... Rising wages...rents...**
**The good news is that there’s still no sign that expectations of high inflation are getting entrenched the way there were in, say, 1980. Consumers expect high inflation in the near future, but medium-term expectations haven’t moved much, suggesting that people expect inflation to come down a lot...** [end quote]
The bond market is predicting 5-year inflation of 2.45%.
https://fred.stlouisfed.org/series/T5YIFR
Krugman doesn’t think that excess wage growth will recede unless the unemployment rate rises…which usually means a recession, though he didn’t say so.
https://www.wsj.com/articles/feds-brainard-to-take-questions…
**Fed’s Brainard Says Lowering Inflation Is Central Bank’s Key Mission**
**She and other central bank officials have signaled expectations for faster pace of policy tightening this spring**
**By Nick Timiraos and Michael S. Derby, The Wall Street Journal, Updated April 12, 2022**
**...**
**Fed officials signaled they could raise rates by a half percentage point at their meeting early next month and begin trimming their $9 trillion asset portfolio, according to minutes of the Fed’s March 15-16 meeting released last week. ...**
**Ms. Brainard said the Fed will continue raising rates, but declined to say whether it will need to lift them in half-point steps. She also said the Fed could formalize plans to shrink its $9 trillion balance sheet at its policy meeting May 3-4 and could start that process in June....At their meeting last month, Fed officials penciled in another 1.5 percentage points in rate increases this year, which would leave their benchmark rate slightly below 2% by December. ...**
**“We are committed to bringing inflation back down to 2%,” though it is hard to say how long that could take, she said. ...** [end quote]
The prediction of raising the fed funds rate from zero to 2% in a year has already impacted the bond market even though the Fed has actually only raised the rate by a teeny-tiny 0.25%. The prediction of sales of the Fed’s bloated book of longer-term mortgage and Treasury bonds has impacted those markets, too, though so far that is jaw-boning.
https://stockcharts.com/freecharts/candleglance.html?$IRX,$U…
https://stockcharts.com/freecharts/yieldcurve.php
Even as bond yields rise, their real yields are far below zero as inflation rises. Even the Wall Street Journal has finally realized the benefits of the I-series Savings Bond. (I hope that the Treasury Department doesn’t cancel this program.) However, every person (or trust) can only buy $10,000 per year of I-Bonds. An alternative is TIPS (Treasury Inflation Protected Securities).
https://fred.stlouisfed.org/series/DFII10
Unlike I-Bonds, which always return full principal whenever redeemed (over 1 year) even if interest rates rise, the value of TIPS fluctuates with interest rates. They can be sold in the bond market but their price will be less than the par value if interest rates rise.
The question is: what to do with money which is not invested in the stock market? Bank accounts yield 0.5% on cash and aren’t likely to raise rates.
Investing in bonds in a rising interest rate environment is always dicey since the value of the bonds will drop.
It’s also dicey to invest in a rising interest rate environment because a recession could result and then the Fed will cut interest rates again.
There’s also a real risk of stagflation: recession plus inflation together. That hasn’t happened since the late 1970s, when the Federal Reserve wasn’t manipulating the bond market the way it does now. At that time, bond investors demanded, and got, positive real yields.
https://fred.stlouisfed.org/series/DGS10
Investing in TIPS if inflation stays higher for longer than the market expects is a gamble. I invested heavily in 10-year TIPS in late 2008 when the TIPS yielded higher than the Treasury (predicting long-term deflation) which was a good move since this unusual deflation only lasted a couple of months. But that’s not the case now – the Treasury yields more than the TIPS.
My current thought is to invest in a series of highly-rated, short-term debt instruments, under 2 years of maturity.
I think it will take more than a few half-point fed funds raises in 2022 to bring 8.5% inflation down to 2%. If they can do that without a recession, I will be the most surprised girl in the room.
Wendy
Maybe the start date (just post COVID scare) was a bit of a dip, but +63% over 2 years is not a sustainable rate. Nor, likely, is the level to which +63% in 2 years has brought the market … given the Fed pivot now in process.