Fed head Jay Powell made the news a couple of months ago when he said it was time to retire the term “transitory” as applied to the wave of inflation. But as we have been saying all along here at Financology, the inflation will indeed be transitory … as transitory as the policies causing it. Powell wasn’t wrong when he said it would be; he was merely wrong in suggesting it would go away by itself. The Fed would have to begin to reverse its massive money printing and interest rate repression.
The latest FDI update shows the first tentative signs of progress. Notice at the far right of the chart the steep plunge in the market value of the dollar has begun to moderate. The Fed may have yet to put its first rate target increase in place, but the bond market has already begun the job for it, and QE tapering is in progress. So long as the Fed follows through on its rhetoric, it will succeed in taming inflation.
We have to recognize, however, that conventional inflation metrics lag badly. The FDI in contrast is a coincident indicator. This means the inflation it registers will take time to be reflected in lagging indicators like the CPI. So it’s quite possible CPI growth will continue or even increase before following suit.
As an interesting aside, note that the wave of inflation being tamed did not begin with covid. It began in late 2018 as the Fed abandoned its last policy normalization effort. It was interrupted by the deflationary crash (FDI spike) associated with the outbreak of covid but reaccelerated by the policy response.
So how far does the Fed have to go to mission accomplished? Some analysts have suggested it needs to get real Fed funds positive. We could nitpick that assessment, but it’s a very empty one, because it fails to define the inflation rate against which Fed funds is compared. With CPI growth in the 7% range, they come up with Fed funds in the neighborhood of 8%.
This is the kind of garbage economists excrete when they ingest faulty premises like CPI=inflation. Fed funds lives in the capital markets. The yield on the S&P500 is in the neighborhood of 1.2%. The yield on the ten year treasury is around 1.8%. Foreign stocks yield in the neighborhood of 3%. These are the relevant neighborhoods. So the Fed need only get Fed funds somewhere into the 1.5%-3.0% ballpark to be competitive. Even 1% will mark substantial progress. The exact level is a moving target but will be apparent when it is approached.
From there, it gets easy. The Fed then just needs to renounce interest rate targeting altogether.