Inflation is building and the Fed will react: DiMartino Booth

I’ve been meaning to do this post for several days now. But a bunch of stuff interceded. You know my opinion about inflation. I don’t see any worrying signs of inflation yet. But we could see an end of cycle rise in cyclical inflation. Still, I am sceptical that this inflation would have lasting impacts. I would expect any recession to wring that inflation out.

But that’s not what matters. What does matter is simply how the Fed thinks about the inflation and chooses to react to it. That’s where Money Strong founder Danielle DiMartino Booth comes in. She knows the Fed from the inside. And she sees inflation that the Fed will act against.

She’s calling this one “Powell and Goliath”. As an aside, let me say I think the new Fed Chairman Jerome Powell has done a remarkably good job at getting almost all Fed officials singing from the same songbook – hawks and doves alike. His regime change to an accelerated timetable has been remarkably smooth. And I think it is testament to his management acumen.

Here’s Danielle on the same issue:

It is imperative that Powell get his Committee on board with recognizing that inflation is an immediate threat before it’s too late, which is not yet the case. Focus in on the blue line which is barely above the Fed’s 2% target. That represents nondiscretionary inflation – the prices of what you have to buy to put food on the table, stay healthy and keep the roof over your head. The green line is inflation for what you want – another pair of red-soled shoes, a bigger curved-screen TV, tickets to the Final Four – you know, discretionary spending.

US inflation, nondiscretionary and discretionary

In recessionary times, the prices for what you need completely disconnect from the prices of what you want – that’s why they are miserable times for the economy. But we’re clearly not there just yet. And the latest data suggest a bit of a reprieve in one critical area – housing. In the most recent CPI report, the cost to rent only rose by 0.2% breaking an endless run of 0.3% prints. That allowed the annual rise to cool ever so slightly to 3.6% reflecting multifamily supply that is finally overwhelming demand. The continuation will come as a huge relief to millions of households who spend a minimum of a third of their take-home pay on shelter.

The good news, though, ends there. It’s no secret that home prices are choking off buyers though rising mortgage rates are doing a bang-up job of getting the hesitant to rush to buy. Applications to buy a home are at a seven-year high even as home prices are up 5.9%, triple the rate of inflation. That helps explain why first-time homebuyers made up all of 29% of buyers in February, a level disturbingly close to the cycle’s 26% record low.

Danielle’s concusion: “If the sensible man in him has no wish to ever allow interest rates to fall to the zero bound on his watch, he might want to get the fed funds rate above 2% before the economy hits recession.”

Again, I don’t want to steal her thunder so you’ll need to read the full subscription piece by becoming a subscriber (Click Here to Subscribe to the Money Strong Newsletter).

My view: there has been a lot of chatter in the markets about disquiet within the Fed’s ranks about having no runway when the next recession hits. I got into this last month when I mentioned that the Fed had cut rates at least 5 1/2% every rate cutting cycle since 1981.

Even Danielle’s 2% level falls well short of those levels. That means that a recession before the end of 2020 when the Fed projects a federal funds rate of 3.4%, will see cutting of some 60% of all prior cycles in the last 40 years.

My views may not line up with Danielle’s on inflation. But her conclusion that the Fed will be out of bullets at the next recession makes sense to me. The last time the Fed was out of bullets was last cycle, after 5 1/2% of cuts. It did three rounds of QE and one Operation Twist.

What the Fed does to counteract the next recession is anyone’s guess.

Source: Powell and Goliath – Money Strong




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