An increasing number of Federal Reserve committee members are vocalizing dissatisfaction at the absolute lack of success on the monetary policy front.
Cleveland Federal Reserve President Loretta Mester said Thursday the January CPI report showed “no improvement in underlying inflation”, it was “clear that inflation was not coming down as quickly as market participants were projecting” and her main message is that the “Fed needs to push interest rates higher to get inflation on a sustainable downward path”.
Today’s prepared remarks from St. Louis Federal Reserve Bank of St. Louis President James Bullard, which indicates that more hikes are needed throughout 2023 to bring the rate of “disinflation” to a level consistent with a stated policy of reducing core inflation to a 2% run rate,
when added to the PPI release that came in “hot” for January,
make it seem abundantly clear that inflation, for the time being, continues to run faster than current interest rates can dampen.
I believe, more likely than not, that a wholesale reset of inflationary expectations will need to be declared at some point in 2023. Earlier this year, I surmised that a 3% core rate would be the eventually adopted target. Now, my working assumption is that the US Federal Reserve will declare a core inflation rate of 4% to be a win.
Should 4% ultimately be the new base, investment implications for leveraged investments and corporations generating low operating margins will continue to be negative. Of equal importance is the implication that the duration of pressure could be be considerably longer than market participants are presently guiding on. Virtually all major investment firms currently model interest rates to peak mid-point 2023, with a presumed downtrend to begin by the fall of 2023. Now, it appears that rates may continue to rise for the entirety of 2023.
Bullish expectations about inflationary pressure abatement appear highly premature.
Government spending growth and increased reliance upon debt funding by consumers continues to thwart the efforts of monetary policy efforts to reduce inflation. Households have, evidently, “consumed and digested” prevailing views that interest rates will peak a shade above 5% and will then drop sharply thereafter. As a result, the public has opted to tolerate higher rates, so long as the timeframe is short and that they can negotiate increased wages. Upward wage pressures continue, supplemented by increased short term indebtedness, to bridge the increased cost of household interest expense.
One year of high inflation is a blip. Two years of high inflation is a concern. Three years of inflation tripling targets? Well, that confirms a full on trend. Absolutely high rates of inflation, both at the producer level as well as the consumer level, are becoming entrenched. This is the exact problem that the US Federal Reserve cautioned on, and tried to curtail without producing a hard landing.
Furthermore, nobody is yet modeling a potential for the Fed funding rate to touch 6% in order to reduce core inflation below a 6% annualized rate. Somebody should, because you cannot reduce inflation to 4% until a 6% annualized rate has been achieved and there are no indications, from the varying Presidents of the US Federal Reserve banks, to support that hope, as of today.
A prior posting indicated a rolling issue with inflation, that being a reliance upon input hedging to “smooth” inflationary increases, rather than eliminate them.
Hedging of commodity inputs by manufacturers only serves to spread out inflationary increases over a longer duration of time. What costs were mitigated in 2022 by multinational manufacturers will be fully evident in both 2023 and 2024. This indication was confirmed since the start of 2023 by Walmart, who noted that some of their biggest suppliers, including Nestle, Coca-Cola Co, Procter & Gamble and Unilever; they disclosed in recent weeks that they plan to embed more price hikes this year. KitKat maker, Nestle, on Thursday said further price hikes were necessary to offset commodity costs.
Consumers, which buttress about 70% of GDP through spending, were behaving rationally through 2022, using the information at hand.
They have been repeatedly advised that inflation was merely temporary, that interest rate increases are transitory and, as a result, are behaving as though the situation will pass of its accord, being remedied with nothing more than time.
Sadly, this was a bum steer spun by those in government and the central banks. They promoted a blissful view to the public that currency printing presses in the 21st century may be run 24-7, largely free of permanent consequence. Now, it is becoming more and more evident that putting the genie back in the bottle is far harder than previously conveyed.
The other problem facing consumers is one of terminology.
The public is failing to grasp the vital distinction between the terms “deflation” vs “disinflation“. Disinflation merely notes a deceleration of inflation (if inflation falls from 8% in 2022 to 6% in 2023, the 2023 prices are still up 6% over the previous year, but is referred to, positively, as disinflation). Deflation, in contrast, refers to an absolute decline in prices. At no point in this inflationary cycle has the Federal Reserve used the term “deflation” in any verbal or written communique to the public; the relative similarity of the nomenclature has, obviously, baffled an overwhelming number of persons, including most in the investment media.
In order to change the operating model of consumers, who misconstrue disinflation to mean the end of rising prices, it may be that more consumers will need to be scared straight, and for that to happen, bankruptcies will need to rise and to be reported.
The Federal Reserve Board is doing what is necessary to reduce inflation:
consumers and governments are not.
Monetary policy is mildly restrictive, yet fiscal policy remains sufficiently accommodating that efforts to diminish inflation are for naught. Government efforts are focused upon buying votes rather than managing economies. Consumers, reliant upon cues from government for spending decisions, are still behaving as though inflation will just pass on, somehow, and soon. This divergence of policy from desire represents the conundrum of 2023.