The Fed's 'See No Inflation' Posture

Pressure, inflationary pressure that is, is starting to grow on the Federal Reserve to start dialing back its mammoth asset purchases and zero percent interest rate policy. While its main position remains that the recent rise in inflation is only “transitory,” the Fed may have at last started laying the groundwork for an earlier move toward to a less accommodative policy rather than waiting until 2023.

That much became clearer in the release of the minutes of the Fed’s April monetary policy meeting last week.

“A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases,” the minutes said. In other words, the Fed revealed that it is at least thinking that it may have to reduce its asset purchases—currently, $120 billion of Treasury securities and agency mortgage-backed securities each month—and possibly raise interest rates earlier than it thought because of the inflation threat brought on by a booming economy and government stimulus.

While it may be fair to cut the Fed some slack and let it be more patient in assessing the shape of the economy post-pandemic before it makes any fundamental policy changes, make no mistake that economic growth and inflation are revving hotter and show no sign of being as “transitory” as the Fed believes.

The headline consumer price index jumped 4.2% on a year-on-year basis in April, up from the 2.6% pace the prior month, making it the fastest 12-month pace since 2008. The core rate, which excludes food and energy, rose at a 3% YOY rate, nearly double March’s 1.6% pace.

Producer prices—which often eventually get passed onto final consumers—are rising even faster. The headline PPI jumped 6.2% YOY in April, the fastest annual pace on record (at least since records were kept starting in 2010), and up four full percentage points just from the prior month. The core rate rose by 4.1%, up from March’s 3.1% rise.

Yet, while just about every investor and everyone who’s recently been shopping knows, inflation is here, the Fed remains to be convinced. Richard Clarida, the Fed’s vice chairman, pronounced himself “surprised” by the CPI rise, even though this is at least the second month in a row of fairly hot inflation numbers. Clarida stuck to the Fed party line that the recent rise in inflation will be, yes, temporary, but that the Fed “would not hesitate to act and to use our tools to bring inflation back down to our 2% longer-run goal.”

I guess it depends on what the definition of the word “transitory” is. Is it six months? A year? Two years? At what point will the Fed recognize what everyone else sees?

For now, other than the hints dropped in the April minutes, the Fed seems to be sticking to its “inflation is transitory” mantra despite all the data indicating otherwise, not just the inflation numbers but the economic growth figures.

Christopher Waller, the Fed’s newest governor, said the economy “is ripping. It is going gangbusters.” Talk about exuberance.

Last week the Conference Board said its index of leading economic indicators rose 1.6% in April after rising 1.3% the prior month. The index “has now recovered fully from its COVID-19 contraction—surpassing the index’s previous peak, reached at the very onset of the global pandemic in January 2020,” the Board said. While the Board cautioned that “employment and production have not recovered to their pre-pandemic levels yet,” it “now forecasts real GDP could grow around 8 to 9% annualized in the second quarter, with year-over-year economic growth reaching 6.4%for 2021.” That doesn’t sound temporary to me.

Yet, the Fed doesn’t want to make any rash moves, even though just about everyone else sees a reason for action sooner rather than later, when it may become too difficult to stuff the inflationary genie back in the bottle.

“We need to see if the unusually high price pressures we saw in the April CPI report will persist in the months ahead,” Waller added.

“For me, it’s a question of risk management,” Randal K. Quarles, the Fed’s vice chair for supervision and regulation, told the House Financial Services Committee last week. “History would tell us that the economy is unlikely to undergo these inflationary pressures for a long period of time.”

That may or may not be true. Unfortunately, we usually don’t find out until it’s too late, and the Fed may have to take much more drastic measures than it currently contemplates, moves that will likely have some serious effects on stock and bond prices. In the meantime, the Fed will keep the pedal to the metal. Let’s hope it doesn’t run us into a brick wall.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.