Inflation v prime rate

The record for the prime rate was 20% and that ran April 2-18, 1980. A year later it was at 17%. (Yeah, I know, the Fed funds rate is preferred these days. But the prime rate is what the media obsessed over back then, as I recall.) The current prime rate is 4.75%.

http://www.fedprimerate.com/wall_street_journal_prime_rate_h…

Inflation peaked at 14.7%, also in April 1980. Currently it is at 9.1%.

https://www.usinflationcalculator.com/inflation/historical-i…

Q: This is just a data point, but it leads to a hunch. My thinking is that short term (?) interest rates need to exceed the inflation rate before inflation will come down. That seems contrary to current Fed policy. The 1% hike in the current betting seems IMO like wishful thinking, that this move will head off inflation.

Thoughts?

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< My thinking is that short term (?) interest rates need to exceed the inflation rate before inflation will come down. That seems contrary to current Fed policy. The 1% hike in the current betting seems IMO like wishful thinking, that this move will head off inflation.>

I agree with you.

Any rate which is lower than the inflation rate is a negative REAL rate. Negative rates are stimulative, the opposite of restrictive, which is what the Fed wants.

The question is: what is the inflation rate?

Look at the Federal Reserve and Treasury Department’s “Real Yield” rates. It makes me wonder what planet they are living on. They are living on “Planet Fed,” not planet “real economy.”

https://home.treasury.gov/resource-center/data-chart-center/…

https://fred.stlouisfed.org/series/REAINTRATREARAT10Y

According to the Fed, "The Federal Reserve Bank of Cleveland estimates the expected rate of inflation over the next 30 years along with the inflation risk premium, the real risk premium, and the real interest rate.

Their estimates are calculated with a model that uses Treasury yields, inflation data, inflation swaps, and survey-based measures of inflation expectations."

The Fed’s 10-Year Real Interest Rate in July 2022 is 1.066%. The market yield of the 10YT is 2.96%. This shows that the Fed estimates the expected rate of inflation over the next 30 years to be 2.96 minus 1.06 percent or 1.90%.

https://fred.stlouisfed.org/series/REAINTRATREARAT10Y

https://fred.stlouisfed.org/series/DGS10

The bond market’s breakeven inflation rate represents a measure of expected inflation derived from 10-Year Treasury Constant Maturity Securities (BC_10YEAR) and 10-Year Treasury Inflation-Indexed Constant Maturity Securities (TC_10YEAR). The latest value implies what market participants expect inflation to be in the next 10 years, on average. It’s 2.36%.

https://fred.stlouisfed.org/series/T10YIE

The Fed isn’t using the CPI or any other consumer inflation rate to base their moves. They are using their own long-term estimates which are far below the actual consumer inflation rate.

The Fed is being very cautious because an astronomical amount of debt was issued at negative real rates. Read the book “The Lords of Easy Money” to see how so-called “zombie” companies were loaded with debt and will default if their debt can’t be rolled over at low rates.

If you (and I) are right, the Fed’s tiptoe policy will NOT control inflation any more than it did in the 1970s.

If you think inflation will stay higher than the market expects, consider investing in I-Bonds and TIPS. I-Bonds are a sure thing at this point.

Wendy

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When Volcker took over the FED the US economy was moving to monetary policies as a means of guiding the economy. Your arguments made sense at that time.

Currently we are moving to fiscal policies guiding the US economy like the much more prosperous 1950 to 1965 period. Monetary policy is much less useful.

Working with the G7 as a cartel and visiting the ME to negotiate, freeing up some Iranian and Venezuelan oil…hopefully investing in the EU and US in alternative energy…over time energy costs are going to come down.

The US has a massive advantage right now. We can build factories, enjoy decreasing input costs with the appreciated dollar, and meet growing internal market demand for goods and services. I am not talking just this year but longer term over the next decade.

It is important to understand the advantages of fiscal policies. We will have much better real GDP growth rates with much more modest inflation rates.

Interesting, leap1. I don’t quite understand. Would you please specify the fiscal policies? Perhaps related, what is causing the dollar appreciation?

Q: This is just a data point, but it leads to a hunch. My thinking is that short term (?) interest rates need to exceed the inflation rate before inflation will come down. That seems contrary to current Fed policy. The 1% hike in the current betting seems IMO like wishful thinking, that this move will head off inflation.

Thoughts?

It is a given. Not a hunch. Inflation plus 2 percent or inflation plus 4 percent.

Proper short rates for this economy are 11.1 to 13.1 percent.

Anything less produces capital mis allocation.

Cheers
Qazulight

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I’m not defending the Fed in this, but if they slammed down a 7% hike, all hell would break loose. I think they will do a series of 1% hikes, with a couple of smaller ones in between to indicate that there is hope at the end of the rainbow. The Fed is not supposed to be political, but this sort of serial policy will cause months (years?) of political screams that they are affecting elections etc.

When trying to determine future Fed policy, consider what action will most protect the profits of the banks that are too big to fail.

The Fed is not there to protect your portfolio, but theirs and they will telegraph, by their actions (not necessarily their words), what they expect the Fed (essentially their trade association) to do.

There will come a time when the acquisition of bonds will be a great long-term investment, but now is not the time.

Jeff

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I’m not defending the Fed in this, but if they slammed down a 7% hike, all hell would break loose. I think they will do a series of 1% hikes, with a couple of smaller ones in between to indicate that there is hope at the end of the rainbow. The Fed is not supposed to be political, but this sort of serial policy will cause months (years?) of political screams that they are affecting elections etc.

When trying to determine future Fed policy, consider what action will most protect the profits of the banks that are too big to fail.

I am not advocating for the FED to do anything. I am pointing out that for inflation to be tamed, the FED must raise rates to inflation plus two percent. The actual number may be quite a bit different than what we would expect now. If the FED does as you and I expect, raise rates gradually and let excess liquidity roll off as bonds mature, then we might (or might not) see inflation fall to 7 6 5 percent as the rates get more normalized. In this scenario, the rates could be 2 percent positive at seven percent.

Of course we could see inflation accelerate because anything less than 2 percent above inflation is accommodative, and tends to keep the economy stimulated. In this case we could see inflation accelerate and even a 11 percent FED funds rate would still be stimulating the economy.

Cheers
Qazulight

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Some additional thoughts.

IMO, the Fed recognizes that the government has too much debt. Inflation depreciates the debt and makes it easier to pay. Taxation without representation?

Quantitative tightening is going on in addition to interest rate hikes. https://www.investopedia.com/quantitative-tightening-is-here…

So, inflation hedges. I have tried the following:

*TIPS: Bought relevant ETF in November, lost 11% or so value. However, some huge dividend payments in recent months, I gather due to resetting.

*DBC, a commodities ETF. Modest gain, but has a contango problem.

*Crypto, a small amount. Bad idea. Tulip bulbs are better.

*REITs. Bought a basket of tickers in January 2021. Modest gain overall with declines this year.

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I am not advocating for the FED to do anything. I am pointing out that for inflation to be tamed, the FED must raise rates to inflation plus two percent

Disagree. Because it happened that way once doesn’t mean that’s the only path out. In fact, I’m calling an “almost top” to inflation now. There might be a bit of overhang, but I’m willing to bet the worst of the worst is behind us.

Why? Well, here is a list of things which have come down in price in the last 60 days: natural gas, lumber, cotton, corn, wheat, soybeans, copper, oil [gasoline, aviation fuel, diesel]. There are others, and decreases are sweeping through the commodity markets. There are a couple of reasons, the most salient of which is that traders who were bidding up futures have decided (or rather that the market has decided for them) that the future is not rising to the sky and they better get out while they can. That is putting a lot of downward pressure across all manner of commodity prices, as indicated in this WSJ piece:

https://www.wsj.com/articles/falling-commodity-prices-raise-…

Then there is the Fed, which has acted belatedly but sufficiently to tell people that it isdoing something, and I expect another message to be sent at the next meeting. That, frankly, will be sufficient, but I expect them to continue to wield the hammmer, probably in smaller doses, through the remainder of the year.

Those commodity price drops will take time to make it to consumer shelves. The price decrease in lumber, for instance, will take six months to a year to be reflected in home prices; and that said we are already seeing a (slight) slowdown of home transfers, price increases, and building starts. Oil prices are coming down, and even the (short term meaningless) announcement by the Saudi’s to increase production to 13m bbl will serve to keep the prices dropping. That redounds through everything, of course: manufacturing and transportation most obviously, but elsewhere too.

Now, does this mean I expect those inflation numbers to hop, skip, and jump back to 2%? Of course not. There’s a lot of overhang: increased rents coming on line, raises being demanded/offered to get employees back, and so on. But the structural inflation that existed in the 70’s (notably COLA union contracts and OPEC) are all but gone in significance, and those were a perpetual motion machine. Now it’s a gig economy and workers begging for raises or retail shops trying to figure out how not to give them and still have people up front. There’s a lot of mess in the economy, from freight containers in the wrong place to hospitals not having beds available because the rooms can’t be cleaned (not because there aren’t enough doctors.) That mess will take time to straighten out; in a few cases it will take the dreaded heavy hand of government, but this too shall pass.

To bring politics in through the side door, none of this will happen timely enough to provide relief by voting day (so bad news for the party in power), and I expect it to be a widely trumpeted issue, but watch the numbers, not the rhetoric. As these real-world decreases work their way through the snake inflation will moderate, helped by the Fed’s overdue actions. By this time next year the numbers will moderate, and your life will go on, albeit at a new, improved, higher base than before.

As usual, macroeconomic forecasts are subject to worldwide events in which case hide under your desk for a while. It’s what we told kids in the 50’s if a nuclear blast was coming, and it’s what we tell them today for active shooter emergencies, so it seems pretty timeless advice.

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The energy markets are building a new premium because of Russia/Gazprom’s recent moves.

This will just bring the G7 cartel into focus.

Disagree. Because it happened that way once doesn’t mean that’s the only path out. In fact, I’m calling an “almost top” to inflation now. There might be a bit of overhang, but I’m willing to bet the worst of the worst is behind us.

Why? Well, here is a list of things which have come down in price in the last 60 days: natural gas, lumber, cotton, corn, wheat, soybeans, copper, oil [gasoline, aviation fuel, diesel]. There are others, and decreases are sweeping through the commodity markets. There are a couple of reasons, the most salient of which is that traders who were bidding up futures have decided (or rather that the market has decided for them) that the future is not rising to the sky and they better get out while they can. That is putting a lot of downward pressure across all manner of commodity prices, as indicated in this WSJ piece:

Goofyhoofy,

I don’t think we disagree as much as you think.

Inflation plus two percent is a moving target. If in the first scenario I mentioned, we could see inflation falling now and the short yield is about 3 percent. Now if inflation falls to say, 4 percent next year, then a short interest rate of 6 percent would be appropriate. Note: if inflation fell to 2 percent the following year, that same rate would still be inside the 2 to 4 percent real return rate of a functioning lending system.

I remember back when we termed the FED’s actions as Calvin Ball rules, even then we had no idea just how accurate that would be for the economy since 2008. So, maybe Modern Monetary Theory really works, or maybe it just seems to work because Cathy Woods at ARK investments is correct and we are in a tech driven deflationary super cycle. (I actually see a lot of merit to her arguments) With that being the case, there can be a strong case that when interest rates were at zero, they were above 2 percent above inflation. I find that the zero bound of interest rates along with deflation makes my head hurt. Maybe it does the FED governor’s also. Might be why 2 percent inflation is the target.

If I were the the FED, and I were reasonable, I would assume my first scenario was likely and keep an eye out for the second. So, I would raise rates and monitor, raise rates and monitor and expect that one day, some interest rate would go from zero percent above inflation to two
percent above inflation without the rate moving at all.

Cheers
Qazulight

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Inflation was 9.1% in June but everyone can see gasoline is much less expensive now.

Poll the public in the US and the economy is bad.

Poll the US public again if their personal situation is good or bad, and everyone pretty much will say their personal outlook is very good.

…yet the economy is bad?

How many people here would say their situation is bad now?

Your stocks are down. Your bonds are down. Many of you are retired and not earning more.

Yet most Americans would say their situation is better now.