–Overheating or Super Squeezing?
By Denny Gulino
WASHINGTON (MaceNews) – Federal Reserve Chair Jay Powell Wednesday reassured his press conference viewers the central bank has the tools it needs to make sure aggressive inflation doesn’t last too long, reinforcing the narrative this inflation episode will meet its match.
But what if the seeds of deflation have already been planted? Was the “pivot” premature? Fed Chair Powell doesn’t know nor does anyone else – yet. The bond market, however, is generating relatively low rates, as if it were already guessing the answer. Nothing Powell said could boost the U.S. 10-year benchmark yield above 1.5%.
And has it been anything more than a prospective pivot? Because nothing much actually happens other than a gradual deceleration in accommodation as the taper progresses to the spring.
As Powell pointed out, accommodation is not being taken away until rate hikes begin and the FOMC has not even begun that discussion. And even if there are three rate hikes next year, how impactful will a fed funds rate of 1% or less be for the economy, or for inflation?
Of course, there’s a different reality in the political sphere, where there is a white-hot urgency to at least appear to be doing something now to counter the sharply higher prices at the grocery story, gasoline pump and seemingly almost everywhere else. So a “pivot” matches the political moment.
Powell’s reassurance matched the assumed playbook that before 2022 is too old, the Fed will be raising interest rates which naturally, plausibly, quenches the overheating that keeps driving up prices – if strong inflation doesn’t fade away on its own.
Powell and his colleagues on the Federal Open Market Committee have been convincing. Few doubt they will be raising interest rates to some degree sooner than seemed appropriate just six weeks ago.
And few doubt that the Fed is equipped to do the job effectively. It has slain the fiery inflation dragon before. Everyone knows the legacy of Paul Volcker who engineered what is certainly among the Fed’s most impressive accomplishments.
Wait a minute. Is there something wrong with this picture? To begin with, the current inflation is peculiar, as Powell himself acknowledged.
“The inflation we got was not at all the inflation we were looking for or talking about in the framework,” the “framework” being the Fed’s pre-pandemic post-financial-crisis operational outline.
“It really was a completely different thing,” he said. “The way we’ve approached it is really nothing to do with our framework.”
Some might say that far from the conventional overheating scenario, current aggressive inflation is more an episode of unprecedented super squeezing, with increased demand being compressed into a smaller production pipe, a pipe that for now can’t be expanded no matter what the Fed does. Turning current demand into pent-up demand, some would argue, doesn’t attack the cause of this inflation’s current energy.
Powell then swerved into a discussion of how to recognize full employment, by looking at quits and wages. He finally returned to inflation, saying its control is really the key to full employment. That could imply the Fed isn’t pivoting at all. It’s just taking a more expansive policy path toward full employment.
Powell’s reasoning was that to get back to full employment, the kind that was spreading jobs even among those on the periphery of the job market before the virus hit, you need a long drawn out expansion.
“To get back where we were the evidence grows that it’s going to take some time and what we need is another long expansion like the ones we’ve been having.” Over the last four decades, he said, “We’ve had I think three of the four longest in our recorded history, including the last one which was the longest.”
That, he continued, “is what we’d like to see and to have that happen we need to make sure that we maintain price stability.”
So, to recap, this inflation is not like what used to be standard fare inflation, too much spending chasing too few goods. Under ordinary circumstances there wouldn’t be too few goods. Again, increasing transaction costs doesn’t remedy what is a somewhat accidental mismatch between supply and demand.
“Automobile purchases are very interest-rate sensitive and you would think,” Powell said, “that demand would drive up the quantity of cars. But it can’t because they don’t have semiconductors. So that was a very different kind of inflation.”
He could also have talked about labor shortages, and how you would think higher wages would increase labor participation. But there’s reluctance to come back into a crowded office or factory because there’s a virus still circulating. There is a pandemic-caused surge in retirements. There is insufficiently affordable child care. There are accumulated savings that give jobseekers options and the opportunity to take their time. He might also have talked about gasoline prices, governed by a worldwide market that doesn’t care about Fed policy.
To tackle this inflation, does the Fed have to tackle supply disruptions, the danger from the virus that keeps workers from working, the international energy market? Are higher interest rates the right tool for that and more that distinguish this particularly strange bout of inflation?
Throughout Powell’s news conference that question didn’t come up. It was and is assumed the Fed has the right tools for the job and that “the job” is to quench inflation.
As Mace News has observed before, there are market graybeards with long memories, who remember when inflation rates and interest rates were really high. They also keep in the back of their minds the fear that aggressive inflation, under the right conditions, can evaporate rather rapidly.
If inflation is indeed peaking, and mechanical problems like backups at the ports and insufficient capacity at the chip fabs turn out to be less persistent, if demand for gasoline and travel dry up because of an exponentially increasing Omicron, if more truck drivers show up and … so many “ifs.”
We know some adverse inflation comps with a shell shocked 2020 are going to roll off early next year. Combined with other deflationary circumstances the Fed’s “job” by next summer might be quite a bit different than the one for which Powell prepared the markets and everyone else Wednesday.
By next summer or fall the Fed could be fighting an even bigger threat to that extended recovery that Powell hopes for, a deflation that vacuums up demand and becomes very difficult to dislodge.
Powell could well be among those graybeards. So again, was his “pivot” to less accommodation and eventual liftoff premature? Among the questions he answered was one from MarketWatch’s Greg Robb who asked Powell, did the pivot “have something to do with your renomination?”
“I’d be happy to talk about that,” Powell answered. He cited the strong third quarter employment cost index, the strong jobs report and the strong CPI on the 12th of November, “I just came to the view over the weekend that we needed to speed up the taper and we started working on it.” He continued, “That’s a full 10 days or so before the president made a decision.”
He went on, “Honestly, it had nothing to do with it whatsoever. … We’re always going to just do what we think is the right thing and I certainly will always just do what I think the right thing is for the economy and for the people that we serve.”
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Contact this reporter: denny@macenews.com
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