The US BLS reported this morning that the March Consumer Price Index rose 8.5% relative to the same month last year. According to Bloomberg this represents the highest annual increase since 1981.
The Fed funds target is 0.25%-0.50%.
The Fed appears embarrassed by such numbers, and is likely frightened by the speed and depth of the decline in Treasury prices since New Year’s Eve. Appropriately so, given that it only takes it days to loosen policy when deflation is in the air, but that when inflation is an established fact, it takes great pains to coddle Wall Street by indulging in denial and then promising months of advance notice before actually taking action.
Powell fiddles as America burns.
This even more striking given that the CPI has been watered down since 1981 … if it were calculated the same way over the decades we’d have to dig deep into the 1970s to find a similar rate.
Yet I maintain that inflation is already below that level. What is making the headlines is the exhaust fumes of inflation. The actual inflation began shortly after the 2008 financial crisis, and then was fed rocket fuel in 2020-2021. As we have discussed before, the price effects of inflation show up first in asset prices. But because policymakers don’t acknowledge it until years later when starts to spill over into consumer prices, it’s a major problem by then and requires a much more vigorous policy response than it would have if nipped in the bud.
Inflation is coming down as a result of the bond market having done all the heavy lifting … it’s already done several rate hikes. The only place rates are conspicuously out of whack with the rest of the yield curve is at the very shortest end … where the Fed – despite all its tough talk about hiking – is holding them down.
The Fed could hike Fed funds by 150 bp tomorrow and do little other than calm the bond market down … except for it having spent years conditioning the markets to expect interminable advance notice and Waiting-for-Godot gradualism. Only because of being conditioned to expect long series of unidirectional moves would markets wonder what might next be up the Fed’s sleeve and freak out.
So what’s next? If asset prices lead consumer prices, just keeping a lid on asset prices will eventually quell consumer price inflation. But that could take a decade or more. As we discussed in The Fed May Actively Seek To Deflate Asset Prices, the link in that chain may be slowly dawning on the official economics community. In which case the strike price on the Fed put has been lowered considerably, while an equally imperative Fed call lurks overhead. Put in plain English, if stocks soar in the months ahead, expect a very aggressive Fed response, while if they fall, they may be allowed to fall further than they would if consumer price inflation is relatively quiescent. In short, the upside potential is sharply limited while the downside has plenty of room.
That too would feel very much like the era of bell bottoms and disco.