No, I haven’t gone schizo. A few days ago I wrote It’s Not About The Fed, in reference to the selloff that had gripped the financial markets, to counter a Wall Street narrative pinning it on a sudden realization the Fed would hold rates higher for longer, apparently to charge the Fed for the incredible demand fiscal deficits were placing on markets for finite capital.
I’ve also written on numerous occasions that we as investors are better off focusing on the Treasury yield curve, not media noise about the Fed, for guidance in structuring our investments. None of this has changed.
But Fed watching as a pastime hasn’t either. And there’s at least one area in which Fed policy has a profound impact on our collective futures.
What prompts this latest commentary is that the volume knob has been ratcheting up on an already pervasive stream of Wall Street cries for the Fed to abandon the 2% “inflation” target that it has articulated since Ben Bernanke’s chairmanship. I put “inflation” in quotes because it in fact refers not to inflation per se but to the annual rate of increase in the Personal Consumption Index (PCE) deflator. Especially the so-called “core” version excluding such nonessentials as food and energy, and even extending to a more fancifully monikered “supercore” version adding shelter to the list of luxuries to be excluded. PCE differs in technical detail but is nevertheless not unlike the CPI in that it tracks US domestic consumption prices. Both are, more accurately, cost of living indexes.
The 2% figure was pulled out of thin air to begin with, so we might be excused for being unruffled by a change. It was apparently motivated by a sort of slippery slope theory that holds that deflation is caused by inflation slipping too low. Never mind our last real world experience where deflation emerged straight out of the bowels of an inflation panic associated with $147 a barrel oil in mid-2008.
The justification for the amped up Wall Street wailing is nominally that the 2% target is too restrictive, that it might result in a “hard landing” for “the economy”. The demand for labor might soften.
That this would purportedly be the concern du jour seems a little more than disingenuous to your correspondent. The front page economic story for the better part of three years has been high inflation, decorated with a ceaseless narrative of an excessive demand for labor relative to supply and an unemployment rate running at multi-decade lows. Employers complaining of worker shortages. If there is any problem in need of fixing, it doesn’t appear to be overly soft labor demand or insufficient inflation.
Not so widely trumpeted is the effect the Fed’s tightening campaign had on Wall Street last year. We remember. The New York Times reported in December that For Many Wall Street Bankers, This Year’s Bonus Season Is a Bust. Investopedia reported in March Wall Street Bonuses Fall 26% to Pre-Pandemic Levels, leaving the average bonus at merely 2.5 times the median American family’s entire annual income.
What we don’t hear as much about from Wall Street is how inflation is hammering the living standards of millions of ordinary Americans. But J Powell has cited it in every post-FOMC press conference since embarking on this tightening campaign, perhaps underscoring his resistance to Wall Street’s demands the Fed back off.
So the Fed’s “inflation” target matters more than it may appear. An increase would signal a shift in the Fed’s stated allegiance from Main Street to Wall Street; as a creature of the latter, the pressure is intense. Not that it would be explained that way, but the signaling value would be profound. If it can go from 2% to 3%, why not from 3% to 4%? And from there to … where?
It would kneecap the Fed’s credibility, potentially resulting in even more restrictive concrete policy being required to achieve the same result. Yet higher interest rates as markets price still higher inflation into yields. It might even crimp the fire hose that has been showering Wall Street with lucre. No question though middle America would be in for even more pain.
There never should have been a 2% target to begin with. But once established, the risk in raising it raises a Pandora’s Box of consequences. Future America could even find itself in a similar struggle as today’s Argentina.