Critique of The Fed’s “Transitory” Response to Rising Inflation
By Victor Sperandeo with the Curmudgeon
“Inflation” is indeed a worry that the Fed continues to ignore. That despite the much higher than expected 4.2% Year over Year (YoY) CPI reported last week - a 13 year high (analysis below)!
The CPI is a very subjective and an understated measure of rising prices as we’ve discussed many times before. In this recent Curmudgeon post, I wrote: “The CPI does not accurately measure inflation. It’s created by bureaucrats at the BLS that tell you what inflation should be if you listen to them.”
Inflation is baked into the 24% increase in money supply, which will continue to rise with the Fed’s financing U.S. government debt with no tapering of QE in the near future.
The Fed’s methadone treatment of the U.S. debt is largely ignored by the mainstream media. We’ve exposed it in several recent blog posts, including Curmudgeon/Sperandeo: Inflation Inevitable as Fed Since Volcker Has Becoming Increasingly Dovish and Sperandeo/Curmudgeon: U.S. Government Deception Exposed; Inflation to Increase.
We elaborate further in this article along with an explanation of a new Fed toolbox trick called “Yield Curve Control.” Let’s first look at negative real interest rates, which together with excess liquidity, have caused the many asset bubbles we’ve been writing about for years.
Negative Real Rates in Perpetuity?
Real interest rates have mostly been negative since the Fed started QE in December 2008. This has never been more true than today. Consider the following:
1. Treasury yields have been negative after inflation for over 12 years. The 10 Year Treasury Note nominal rate is at 1.63% as of Friday. That’s a current negative real rate of 2.57% using April’s 4.2% CPI year over year increase. And you have to wait a full 10 years to get your money back.
2. What about short-term rates? Consider this tweet by Jesse Felder on the Fed Funds rate:
3. For the first time since 1980 (or 41 years), the CPI is rising faster than the average mortgage rate. Freddie Mac’s rate for a 30-year mortgage averaged 3.1% in the same month, a smidgen above record lows. That puts the interest rate on home loans at 1.1% below inflation or a negative real rate of return for mortgage lenders.
Over the past 50 years, mortgages were an average 4% above the inflation rate, although that gap’s been halved in the past decade due to the Fed’s ultra-easy and unconventional monetary policies since Lehman went bankrupt in September 2008.
Higher Than Expected CPI Reported, but Fed Yawns:
The U.S. Bureau of Labor Statistics (BLS) reported on May 12th that the CPI for urban consumers increased 0.8% in April on a seasonally adjusted basis vs the expected 0.2% by economists. The CPI rose 0.6% in March, which was also more than expected.
Over the last 12 months, the CPI increased 4.2% (vs 3.6% forecast) before seasonal adjustment. This is the largest 12-month increase since a 4.9% increase for the period ending September 2008.
The CPI core was also up much more than expected at 0.9% on a monthly basis and 3% YoY. The respective estimates were 0.3% and 2.3%.
Here’s a Bank of America chart on the Core CPI components with the biggest % month-over-month changes in April and their contributions to the 0.9% pop in the core CPI:
Source: BofA Global Research, Bureau of Labor Statistics
The shockingly high CPI numbers begged the Fed to say something to temper the markets concern about accelerating inflation. Yet Chaiman Jay Powell maintained his belief that inflation (i.e., price increases rather than money supply growth) are “transitory.”
Perhaps, Powell was thinking that because inflation was very low one year ago (but has risen since), the year over year (YoY) CPI numbers would decline in future months. But for at least the next three months, the YoY CPI increases will likely be equally as large or larger, because much of the U.S. economy was still in lockdown during May-June-July of 2020.
Bank of America, other investment banks and several research houses believe inflation will be persistent rather than transitory.
Bank of America Global Research on “Transitory” Inflation:
The inflation forecast is a story of three phases:
1) temporary burst of inflation as shortages drives up goods prices and reopening support services;
2) softening or reversal of goods inflation and leveling off of services inflation leaving tame monthly core inflation prints starting in 4Q.
3) pace of tightening in the labor market pushes core inflation modestly higher at a more measured pace.
The risk is that the repeated price increases in phase 1 will send inflation expectations soaring. Higher expectations combined with wage growth could convert temporary inflation into persistent.
Monitoring inventories will help to understand the inflation picture. The real inventory-to-sales (I/S) ratio has reached a record low (see chart below), highlighting the imbalance in the economy.
Autos are the biggest standout but nearly every major retail category witnessed a decline in the real I/S ratio. This is a function of both demand and supply: the stimulus and reopening-fueled burst in demand was not matched by a comparable gain in supply. Instead, production has been hampered due to COVID-related supply chain issues and labor shortages.
“Transitory” can feel like a long time says Bank of America! The investment bank thinks we are many months away from the economy feeling more balanced and that inflation will stay high till then.
Nordea Bank Forecasts 8% U.S. Inflation by Summer:
Nordea investment bank is one of many that believe inflation will continue to increase. Nordea’s trend-model suggests that U.S. inflation will be close to 8% (YoY) by this summer before declining to an annual rate of almost 5% by year end. That’s shown in this chart of their trend-model vs CPI YoY:
Nordea asks, “Is this enough to scare you? Apparently, it hasn’t scared the Fed!
The Nordic bank says that the true test is whether inflation will stay high after summer. The “direct bonuses” of the Biden administration will run until September, but in parts of the U.S. the stimulus checks will already be halted during June (e.g., in Iowa and Mississippi). That will provide an early look at how the labor market looks post the federal government money handout.
Do you think the Fed is in denial of rising inflation or is it being influenced by its secret owners to keep blowing bubbles?
The Markets Response – Nirvana Fantasy Land:
When not a word was “spoken” on 5/13/21 by the FOMC members about inflation worries, the markets all resumed their upward trajectory into the twilight zone, also known as nirvana fantasy land.
The coup da grace came Friday. Why were the markets up in a big way and bond yields declined a few bps? It was because the markets assess the Fed doesn’t care about inflation and will keep monetizing the debt with no taper or rate rise in sight.
Moreover, the NY Fed suggests that “Yield Curve Control” [1.] will now be implemented. You can read the hieroglyphics of spin written in “Fed Speak” in an excerpt from a May 13th NY Fed statement (emphasis added) which the markets cheered by rallying on Friday:
Effective May 14, 2021, the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York is making technical adjustments to its purchases of Treasury securities conducted on behalf of the Federal Open Market Committee (FOMC). Specifically, the Desk is updating the maturity ranges for its purchase sectors and the associated sector weights to ensure that the allocation across sectors remains roughly proportional to Treasury securities outstanding in those sectors….the Desk will segment its purchase sectors for longer-dated securities into additional maturity ranges to reflect last year’s introduction of a new benchmark security. The Desk will also update associated sector weights.
I have no idea what the new “benchmark security” is, do you?
Note 1. Under Yield Curve Control, the Fed would target a fixed longer-term rate and pledge to buy enough long-term Treasury bonds to keep the rate from rising above its target. In theory that would enable the Fed to stimulate the economy, but in reality, it would be just another financial market backstop (like QE and ZIRP).
SIDEBAR: The Fed is Playing with Fire:
A May 11th WSJ editorial by Christian Broda and Stanley Druckenmiller is definitely worth reading. Here’s an excerpt:
Normally at this stage of a (economic) recovery, the Fed would be planning its first rate hike. This time the Fed is telling markets that the first hike will happen in 32 months or 2½ years later than normal. In addition, the Fed continues to buy $40 billion a month in mortgages even as housing is clearly running out of supply. And the central bank still isn’t even thinking about ending $120 billion a month of bond purchases.
The emergency conditions are behind us. Inflation is already at historical averages. Serious economists soundly rejected price controls 40 years ago. Yet the Fed regularly distorts the most important price of all—long-term interest rates. This behavior is risky, for both the economy at large and the Fed itself.
Even after trillions spent to prop up the bond market, foreigners have continued to be net sellers. The Fed chooses to interpret this troubling sign as the result of technicalities rather than doubts about the soundness of current and past policies.
Fed policy has enabled financial-market excesses. Today’s high stock-market valuations, the crypto craze, and the frenzy over special-purpose acquisition companies, or SPACs, are just a few examples of the response to the Fed’s aggressive policies. The central bank should balance rather than fuel asset prices. The pernicious deflationary episodes of the past century started not because inflation was too close to zero but because of the popping of asset bubbles.
Chairman Jerome Powell needs to recognize the likelihood of future political pressures on the Fed and stop enabling fiscal and market excesses. The long-term risks from asset bubbles and fiscal dominance dwarf the short-term risk of putting the brakes on a booming economy in 2022.
An Andrew Jackson observation (more in End Quotes) is related to the Fed’s negligent stance on inflation: “I weep for the liberty of my country when I see at this early day of its successful experiment that corruption has been imputed to many members of the House of Representatives, and the rights of the people have been bartered for promises of office.”
The implications for today’s Fed and U.S. government officials in power are crystal clear:
· If the statistics on fiat money printing are too high -hide them!
· If the economy is not stimulated by Fed easy money than manipulate the GDP numbers!
· And by all means lie, deceive and mislead the public to keep the stock market casino on a roll.
Powell’s Fed Chairman’s term is coming up for renewal early next year. Perhaps, Powell will become a real man and speak the truth before then?
We will continue to see high inflation “results” from federal government spending madness and ultra-easy monetary policies which is akin to a fiat money drug disease (with a cover up of the results by ending the money supply reports).
The Fed will likely continue to manipulate yields using Yield Curve Controls. This last tool in the toolbox not used yet is also called “interest rate repression.”
The U.S. system of government is in dire decline, as I’ve so often said. I hope I’m wrong, but the way the Fed is handling the inflation problem is very ominous for the long-term system of liberty the U.S. was built upon.
End Quotes (especially meant for those in power):
“Any man worth his salt will stick up for what he believes right, but it takes a slightly better man to acknowledge instantly and without reservation that he is in error.” Andrew Jackson, 7th U.S. President.
“Every man is equally entitled to protection by law. But when the laws undertake to add... artificial distinctions, to grant titles, gratuities, and exclusive privileges—to make the rich richer and the potent more powerful— the humble members of society—the farmers, mechanics, and laborers, who have neither the time nor the means of securing like favors to themselves, have a right to complain of the injustice of their government.” Andrew Jackson
(The Curmudgeon and I firmly believe this quote captures the essence of the U.S. degradation today.)
Finally, a mystic’s quote to understand the process of government deception and cover-ups.
“When the human race learns to read the language of symbolism, a great veil will fall from the eyes of men. They shall then know truth and, more than that, they shall realize that from the beginning truth has been in the world unrecognized, save by a small but gradually increasing number appointed by the Lords of the Dawn as ministers to the needs of human creatures struggling to regain their consciousness of divinity.” Manly P. Hall 1934.
Let’s hope that the Fed and government officials heed this quote and start telling the truth!
Stay safe, be healthy, take care of yourself and each other, and till next time……
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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