January 2022

Without a doubt, the Federal Reserve should have raised the overnight interest rate interest rate today, February 10th.  The Bureau of Labor Statistics (BLS) released the January inflation report and, again, it shocked to the upside.  Consensus expectation was that prices would have risen 7.3% year-over-year.  Instead, prices rose 7.5% over last year’s basket.  The Fed has 2% as their stated target for inflation and when inflation began to exceed that target last year they revised the mandate somewhat to say 2%, on average, given the vagaries of the economic cycle.

Parsing the individual components of the inflation report, the only category that did not exceed 2% was education, rising 1.7% for the year.  At the opposite side of the spectrum, energy was up 27%, and the gasoline subcomponent was up 40% compared to last year.  For the same period, new car prices rose 12.2% and used car prices rose a whopping 40.5%.

As we’ve written on numerous occasions, the pre-Bernanke Fed was loath to communicate their intentions with regard to monetary policy, preferring the “invisible hand” in making their adjustment to policy.  At the behest of Ben Bernanke, the Fed adopted an open communication policy in the belief that such communication allowed them another tool in their adjustment of monetary policy.  Our concern when they instituted that policy was that it’s not equally beneficial when the Fed is on the wrong side of policy, like they have been for arguably over a year.  Market participants were clamoring for the Fed to back off of Quantitative Easing last year, while the Fed communicated that they believed that inflation would prove transitory and kept emergency monetary policy stimulus in place.  Even when it became apparent to all, including the Fed, that inflation was absolutely not transitory and they admitted that they would need to adjust policy, they continued with QE.  As communicated, emergency monetary policy is set to continue into next month and the Fed will presumably raise the overnight rate on March 16th by what some are saying will be 50 basis points.  Our question is why wait another month to adjust policy when the Fed is clearly well behind in the process of normalizing interest rates.  Members will surely cite the risk of losing credibility if they do not do what they have said they are going to do.  The problem with that argument is that they lost credibility a long time ago.

We wonder if the Fed’s communication policy goes both ways because investors are sending a message to the Central Bank as to what they expect of policy this year.  According to Fed Fund futures, investors are expecting a 50 basis point hike in March and a total of 150 basis points by the end of this year.  That’s a sharp departure from expectations last summer and we wonder if that move, paired with a departure from pandemic-related giveaways will tank the stock market.  Indeed, the January 2024 Fed Fund future is slightly inverted to the December 2023 future, which we interpret as speculation that after moving aggressively to contain inflation, the Fed will need to reverse course to stave off a recession.  Of course, such speculation is making an awful lot of suppositions, but that’s what the Fed has done to itself by falling so far behind in monetary policy management.

By April, the year-over-year comps should flatten out somewhat, but it seems likely that the price point for goods in this economy has been permanently elevated and the implications are already being felt.  To meet the heightened cost of living, workers are demanding pay increases and employers have been forced to raise earnings to attract talent.  While gas prices may drift lower as the supply squeeze eases, worker’s wages will not.  Liberal politicians move to raise the minimum wage to $15 an hour, was a controversial proposal two years ago, but now is the low end of the wage spectrum.

Coincidently, Freddie Mac announced that the average mortgage rate has risen to 3.69%.  That’s more than 100 basis points off of the low hit last year.  We wonder how that will impact the surging price of home ownership, especially amid the low level of inventory currently on the market.  For now, we don’t expect that it meaningfully suppresses demand.

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