Fed plans to raise rates as soon as March to cool inflation

[Person Man]

Federal Reserve Bank of St. Louis President James Bullard said the central bank needs to move quickly to raise interest rates to around 3.5% this year with multiple half-point hikes and that it shouldn’t rule out rate increases of 75 basis points.

This is still too conservative.  Interest rates needs to be at or above inflation.  I would raise rates to at least 6% 

Is this some arbitrary rule or is there evidence for this?

[Person Man]

Federal Reserve Bank of St. Louis President James Bullard said the central bank needs to move quickly to raise interest rates to around 3.5% this year with multiple half-point hikes and that it shouldn’t rule out rate increases of 75 basis points.

This is still too conservative.  Interest rates needs to be at or above inflation.  I would raise rates to at least 6% 

Is this some arbitrary rule or is there evidence for this?

Mostly about the time value of money.  When one party borrows money from another what is taking place is one party is deferring consumption in favor of someone that needs to consume resources earlier.  The rate of interest is compensation for such deferring of consumption.  It is illogical to set such an interest rate below the rate of inflation since in real terms you are asking the lender to pay the borrower to borrow money.   Historically the fed rate has always been above the rate of inflation with rare exceptions during recessions.  Even then the real int4erest rate being negative only lasts a year or so before reverting to being positive. 

Since 2008 this has been broken and it was only in 2018-2019 that the real interest rate become slightly positive again.  Even with base effects, one can argue that inflation is running at a 5%-6% at least so interest rates should be set there if not higher if the Fed is going to get inflation under control.  Unforintelly the Fed is still living in a post-2008 world and not realizing that you cannot just live in a permeinate emergency world without very problematic side effects.

So your objective would be to essentially shrink the money supply by making the government lend to banks at the same rate that money depreciates?

[Person Man]

It seems in interest rate markets there are now more bets on  multiple 75-basis-point rate this year.  That is not the consensus but it is good to see this is the way the Fed might move.  Moving rates to 2.5% by the end of the year is a complete joke.  Much more aggressive action is needed the massively reduce the liquidity in the market.

More aggressive action would lead to a recession, many economists are worried that even as far as the Fed will go could  lead to recession. Rates need to go up yes, but it needs to be done gradually so that economic growth does not slow too much, all at once.

For me, a recession is a feature and not a bug.  A recession will allow for labor and capital engaged in value-destroying activities to be reallocated to value-creating activities.  Right now we have a situation where you are paying people to borrow money (in after-inflation terms.)  The longer this goes on the greater the economic distortions and worse the long-term economic growth prospects will be.

I pretend to be a sociopath sometimes for fun, but dude cmon. 

The sad (but inevitable) fact is that in the long-term a recession of some kind is inevitable. Dread it, run from it, market distortions (and excessive debt) bring recessions or even depressions all the same. In that way, they are more akin to forest fires than anything else. Recessions are part of the economic cycle. It's better to have several small ones than one big one.

Of course, what is most likely to happen if we have another recession is that the government simply puts boatloads of money in the hands of corporate America - again (not like they didn't already do that during corona). Essentially, that is corporate welfare. And it's funded by us, John Q. Public, whether we will it or not. I'm not necessarily hostile to that, because stability could be quite desirable here, but it's not exactly without downsides either.

Yes, but the difference between a normal informed person and Jaichind is that the former doesn’t actively cheer for a recession.

I mean, at this point, it is in his interest, as a wealthy man, for this to happen.

[Person Man]

Fed rates swap markets now price in a 50/50 chance of a 75 basis points hike in June.  That would be the largest jump in Fed rates since 1994 and it seems very necessary.

We can't only rely on interest rates increase even though some are necessary over the long term.

[Person Man]

Hopefully, now the Fed faces reality and put a 75 bp and in my view a 100 bp increase on the table for the next Fed meeting.  The market pricing clearly thinks this is the case (at least the 75 bp part)

So we should expect mid-term stagflation?

I would say that the equities markets are pricing in around a 50% chance of a recession next year.  I think if it falls another 5% or so then the chances of a recession next year is very high. 

About what I assumed, although we might get the official "recession" as soon as next quarter.

Anyway, I have already started buying the dip a bit, but not sure how much I should leave for later. Think we could lose more than 10% to ATL from this point?

I know I am.

[Person Man]

The good news is that consumers are finally saying “enough”.

[Person Man]

Revised 2022 Q1 QoQ GDP came in at -1.5% from the initial -1.3%.  What is striking is that net exports knocked 3.2% off this figure which implies very robust demand but supply that cannot keep up with demand.  

Ever since 2008, the Fed has been operating under the assumption that real GDP is operating below potential GDP ergo ultra-loose monetary policy is needed to get demand to meet up with potential GDP.  The low levels of inflation, which is also about deleveraging from the 2007-2008 bubble, seem to validate the Fed assumption.

The latest GDP numbers seem to indicate a massive policy miss collectively by the Fed, Trump administration, Biden administration, and congressional leaders of both parties.  The COVID-19 lockdowns seem to have permanently lowered USA's potential GDP trajectory while all policy makers  
assumed that the post-2008 world where demand was always below potential GDP.  The result is the current inflationary crisis which now can only be solved by normalization of interest rates to a pre-2008 norm.

We were kind of on our way before the pandemic. Didn't we get up to 3%? We were at 5% before right?

[Person Man]

Holy cow ... CPI YoY came in at 9.1% ... MoM was 1.3%.  This is out of control .  The Fed has to get going in 100 bp increases.

Three 75 pointers in the next year would be reasonable. That would bring us to 375-4. About where it normally is.

[Person Man]

JPM's Dimon: "Inflation Will Rise A Little Bit More Than People Think"

What do you mean by “a little”?

[Person Man]

Federal Reserve Bank of St. Louis President James Bullard said the central bank may need to raise interest rates to 3.75% to 4.0% in 2022 versus the current consensus of 3.5%

That's probably about right.

[Person Man]

Looking at the previous CPI report and expected CPI report coming up it seems that the situation is getting under control.  Stripping out energy and food the CPI MoM last month was 0.3% and is expected to be 0.3% in the next report.   This is compared to the ~0.6% non-food/energy CPI MoM last few months.  It seems the big inflation spike momentum earlier in the year is slowing down.  This is a moderate version of what happened in Russia where there was a massive price spike in Feb-April but then have actually moved into deflation with negative CPI MoM.  This slowdown is taking place even though the Fed Funds rate has only moved up somewhat.

I think the reason for this is high inflation expectations by the late 1970s took very prolonged high Fed Fund rates to wipe out whereas recent inflation expectations in the 1990s-2010s period have been and stayed low.  This is helping restrain inflation.   If so then perhaps the "team transition" of 2021 might have been right.  What took place was two large inflation hammer blows in 2021 and then 2022 but both then dissipated.  What "team transition" got wrong was the scale of the spike but they might have been right all alone. To be fair we will know more over the next few months are more CPI MoM data comes in.

This all collaborates that we probably need to go back to historically normal interest rates (3-5%).

[Person Man]

What would be the problem with more historically normal inflation(3-4%)?

[Person Man]

What would be the problem with more historically normal inflation(3-4%)?

There would be a problem for the Central Bank to not have price stability.  The Central Bank is competing against other stores of value (gold etc etc) so price stability would mean the value of a currency is stable and people would use it more than its competition.  So in theory Central Bank would want 0% inflation.  The 2% target in the USA came into place mostly due to fears of deflation and a liquidity trap.

How did things work with 3% inflation?

[Person Man]

It seems what drove up the latest inflation number is rents.  If so that is a lagging indicator since many rent contracts most recently neglected might and most likely are reflecting the rise in the rental market that took place months ago.  In that sense, these are grounds to believe that this surge might subside the next data points.  Still just to make sure I still think it is best that the Fed push rates up to 4.5% and beyond.  It can always lower them later.

Anything higher than 4.5 will probably lead to Volknerization but 4 to 5 seems reasonable. So two more major rate hikes?

[Person Man]

What would be the problem with more historically normal inflation(3-4%)?

There would be a problem for the Central Bank to not have price stability.  The Central Bank is competing against other stores of value (gold etc etc) so price stability would mean the value of a currency is stable and people would use it more than its competition.  So in theory Central Bank would want 0% inflation.  The 2% target in the USA came into place mostly due to fears of deflation and a liquidity trap.

How did things work with 3% inflation?

Well, the higher that number is the more you are driving "forward" planned consumption since the purchasing power of the currency is falling.  Where the economy is in a liquidity trap where supply way outstrips demand this might have some good short-term effects without creating long-term problems.  If not you are just adding uncertainly in the system and lowering logical investments and risk taking.

Conversely, we don't want people eating ramen, cutting their streaming services, driving a car that breaks down every couple of months, never going on vacation, wearing clothes that have holes in them, and using furniture that smells funny just because "if we wait to buy this, we'll save $".

[Person Man]

It seems what drove up the latest inflation number is rents.  If so that is a lagging indicator since many rent contracts most recently neglected might and most likely are reflecting the rise in the rental market that took place months ago.  In that sense, these are grounds to believe that this surge might subside the next data points.  Still just to make sure I still think it is best that the Fed push rates up to 4.5% and beyond.  It can always lower them later.

There's probably still a ways to go, unfortunately. I didn't realize how behind CPI was compared to other measures of rents.

Yes.  My point is that inflation might be running at over 8% but the average person might not be "experiencing" 8% anymore due to rent component catchup.  For most people, the rental market became crazy a year ago which they experience but is only now showing up in CPI numbers.

That might mean that raising interest rates too high might be unnecessary.

[Person Man]

It seems what drove up the latest inflation number is rents.  If so that is a lagging indicator since many rent contracts most recently neglected might and most likely are reflecting the rise in the rental market that took place months ago.  In that sense, these are grounds to believe that this surge might subside the next data points.  Still just to make sure I still think it is best that the Fed push rates up to 4.5% and beyond.  It can always lower them later.

There's probably still a ways to go, unfortunately. I didn't realize how behind CPI was compared to other measures of rents.

Yes.  My point is that inflation might be running at over 8% but the average person might not be "experiencing" 8% anymore due to rent component catchup.  For most people, the rental market became crazy a year ago which they experience but is only now showing up in CPI numbers.

That might mean that raising interest rates too high might be unnecessary.

Agreed. If inflation is already really only running at 10-20 bps a month (taking into account diving gas prices but also lagging rent data), then inflation is back to a "normal" level already. That doesn't mean we should lower interest rates, but it does mean that we should consider not raising them too much more than present and perhaps even slightly lower than market expectations.

It's odd that the August report was presented as negative when it actually looks quite positive.

A lot of great deals in the stock market from today, then.

[Person Man]

It seems what drove up the latest inflation number is rents.  If so that is a lagging indicator since many rent contracts most recently neglected might and most likely are reflecting the rise in the rental market that took place months ago.  In that sense, these are grounds to believe that this surge might subside the next data points.  Still just to make sure I still think it is best that the Fed push rates up to 4.5% and beyond.  It can always lower them later.

There's probably still a ways to go, unfortunately. I didn't realize how behind CPI was compared to other measures of rents.

Yes.  My point is that inflation might be running at over 8% but the average person might not be "experiencing" 8% anymore due to rent component catchup.  For most people, the rental market became crazy a year ago which they experience but is only now showing up in CPI numbers.

That might mean that raising interest rates too high might be unnecessary.

Agreed. If inflation is already really only running at 10-20 bps a month (taking into account diving gas prices but also lagging rent data), then inflation is back to a "normal" level already. That doesn't mean we should lower interest rates, but it does mean that we should consider not raising them too much more than present and perhaps even slightly lower than market expectations.

It's odd that the August report was presented as negative when it actually looks quite positive.

A lot of great deals in the stock market from today, then.

I'm a buy-and-hold sort of guy. In any case I can't (easily) trade in individual stocks due to my job.

I'm not a day trader, either. It's just I had very aggressive positions before this fiasco and I am still buying into aggressive positions now. It's all going to be worth it. They definitely overreacted

Wholesale prices dropped 0.1% last month. Would give the link, but I am on the bank(where I work)'s computer.

[Person Man]

Fed Fund swap trading indicates that the marker expects rates to peak sometime next year at 4.5%  If such expectations ends up than that expect equity markets to fall some more from here.

Two 75s would get us to 4.

[Person Man]

Fed raises rates 75 bp as expected.  Powell says that a recession might be necessary to bring inflation under control.

For the first time using my inflation-adjusted yield curve (discounting the yield curve with inflation swaps at each tenor) as the curve inverted (the convention curve has been inverted for a while) although only mildly.  It does seem that a recession next year is coming.   Given how mild my my inflation-adjusted yield curve is is it possible that it will be a mild recession.

So basically like the recession caused by 9/11/computer bust but maybe much more broad with the same volume (there won't be a sector that is totally destroyed like commercial banking (1990)/residentials(2008)/technology(2001)..et al..)

I'm still hoping for an environment that doesn't kill most people's chances of advancing their career.

[Person Man]

My calculated 30-year inflation-adjusted yield (which discounts the 30-year treasury yield by the 30-year inflation swap) reaches 1.22% which is the highest since 2011.   It was -0.6% in early 2022.  The pre-2008 era has this metric between 1.5%-2.0%.  I think we are getting very close to the end of the adjustment transition to the pre-2008 era as far as federal borrowing costs are concerned.

So people are selling stock and even commodities/metals to lend the Government money because it’s willing to pay more?

[Person Man]

PCE Deflator MoM came in at 0.3% as opposed to 0.1%.  The trend is still negative.  Hopefully, the recent rate increase and more to come will start to get this under control.

Is this a sign that inflation is decreasing too fast, too slow, or about right? People are beginning to worry about deflation.

[Person Man]

PCE Deflator MoM came in at 0.3% as opposed to 0.1%.  The trend is still negative.  Hopefully, the recent rate increase and more to come will start to get this under control.

Is this a sign that inflation is decreasing too fast, too slow, or about right? People are beginning to worry about deflation.

MoM at 0.3% is not bad but not that great.  What it means is that PCE (personal consumption expenditure) Deflator (which is the Fed's preferred way to measure inflation) is rising at a 0.3% annual rate in one month which would work out to around a 4% annual rate.  Note that deflator is not deflation but how it gets calculated where you figure out the real PCE of each month and then look at nominal PCE to derive how face PCE prices are rising.

So real inflation right now is about 4%?

[Person Man]

PCE Deflator MoM came in at 0.3% as opposed to 0.1%.  The trend is still negative.  Hopefully, the recent rate increase and more to come will start to get this under control.

Is this a sign that inflation is decreasing too fast, too slow, or about right? People are beginning to worry about deflation.

MoM at 0.3% is not bad but not that great.  What it means is that PCE (personal consumption expenditure) Deflator (which is the Fed's preferred way to measure inflation) is rising at a 0.3% annual rate in one month which would work out to around a 4% annual rate.  Note that deflator is not deflation but how it gets calculated where you figure out the real PCE of each month and then look at nominal PCE to derive how face PCE prices are rising.

So real inflation right now is about 4%?

If the MoM numbers continue this way.  4% is not good.  Fed wants it to be 2%

That could be where we end up if we are becoming more of a manufacturing country, out of necessity, and have higher growth.

[Person Man]

So will atlas admit we are in a recession?

https://twitter.com/AlanReynoldsEcn/status/1603785731587166209?t=92BefM30_KPCnEn...

It's not like there is anything we can do about the Fed at this point. If there is, that would be good to know.