Fed Words and Actions Under Microscope After CPI Reading

FS Insight Team

Federal Reserve Chairman Jerome Powell did ask for more inflation publicly many times. The old adage be careful what you wish for comes to mind. The reading was true surprise, not a slightly higher reading than expected. There is no doubt that some of this is transitory as the Fed postulated—record demand is meeting strained and, in some cases, broken supply chains. This is causing shortages in price spikes all across economy. If you have a used car to sell, by the way, now is probably the time. Prices jumped 10% (this accounted for roughly a third of the month’s CPI increase). The previous fact shows how the data comps are causing some numbers that may be distorted.

A typical after effect of pandemics may be partially at play. A worker shortage is pushing wages up, which may be starting to feed into increasing prices. We discussed the nature of the CPI data with our data science team. We think it is distinctly possible that CPI numbers next month could be even higher. This is partially due to the comps, a year ago the economy was undergoing an unprecedented shutdown. It’s also due to the supply chain interruptions, rising commodities and food prices and other transitory factors. The big question is if the Fed is misreading the inflationary forces. Is this an awakening beast that will result in monetary folly? Only time can tell; however, the Fed itself seems pretty assured in sticking to its ultra-accommodative course at this time.

So, before you get leisure suit and disco records out, remember that CPI was severely exaggerated by base effects. Also used cars, hotels and car rentals made up significant portions of the total increase. The surge in some of these prices which were foundational to the number running so white hot are almost certainly temporary. A year from now they could very well be dragging prices down. We live in an incredibly anomalous time if you didn’t notice. Nonetheless, the pressure is raised on the Federal Reserve and another month of data will probably get them to start “thinking about thinking about” dialing back the accommodative stance. We’re very sure they will try their best to do this as delicately as possible, particularly since Chairman Jay Powell’s position is up in the air and comes back up for re-evaluation in February 2022. His response to the current situation very well may define our economic future, and certainly his career and legacy as well.

The Fed was put under extra scrutiny this week after the somewhat shocking inflation numbers. The employment data has shown more weakness than other areas of the economy. Fed Governor Waller said in a speech that the Fed would need to see months more of data to make any decisions. In other words, the party line that inflation is transitory is what they’re sticking to despite the big surprise. The Fed puts a lot of this off to calendar effects. The comparable period a year ago was of course during the height of the pandemic.

Vice Chairman Clarida also gave a speech that largely stuck to the transitory party line. He believes that inflation will moderate with normal comps and when supply bottlenecks are resolves. He cited recent labor market weakness as reason to continue accommodative policy.

Asset purchases continued at a pace of $40 billion a month for MBS and $80 billion a month for Treasuries. The benchmark yield on the 10 year is 1.635%.

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