via notayesmanseconomics:
Today is the morning after the night before and let me hand you over to the Financial Times to explain why.
The Federal Reserve raised its benchmark interest rate by a quarter of a percentage point on Wednesday to the highest level in 22 years, as it wrestles with how much more to squeeze the US economy to bring inflation under control.
The Federal Open Market Committee lifted the federal funds rate to a new target range of 5.25-5.5 per cent with unanimous support, resuming its most aggressive monetary tightening campaign in decades.
It provides my first point which is that it is quite some time since we have seen anything like this. Frankly until recently interest-rate rises have been rare and pretty immediately reversed. There is a further point to this and I found it in the Federal Reserve statement.
With today’s action, we have raised our policy rate by 5-1/4 percentage points since early last year.
So after a long period of near zero interest-rates they embarked on a rush to try and catch up after their mistake in calling the largest surge in inflation for decades “Transitory”. Their attempt to present this as a type of “macho” monetary policy falls rather flat if you note the details in the statement. The emphasis is mine.
We have been seeing the effects of our policy tightening on demand in the most interest-rate-sensitive sectors of the economy, particularly housing and investment. It will take time, however, for the full effects of our ongoing monetary restraint to be realized, especially on inflation.
Just as a reminder controlling inflation is their job as their actions were described by Carole King.
And it’s too late, baby, now it’s too lateThough we really did try to make itSomethin’ inside has diedAnd I can’t hide and I just can’t fake it
Earlier he had another go.
We have covered a lot of ground, and the full effects of our tightening have yet to be felt.
It is the fault if him and his colleagues for being late to the party. He tries to cover it up with this.
Inflation remains well above our longer-run goal of 2 percent. Over the 12 months ending in May, total PCE prices rose 3.8 percent; excluding the volatile food and energy categories, core PCE prices rose 4.6 percent. In June, the 12-month change in the Consumer Price Index, or CPI, came in at 3.0 percent, and the change in the core CPI was 4.8 percent.
The use of core numbers looks not a little desperate as he needs higher numbers to justify the interest-rate rise. The CPI is now 3% and the PCE number will fall back towards that when we get the June number. So interest-rates were already around 2% over inflation which is the “old school” requirement to reduce it, and he says himself the full effect of past increases has yet to be felt.
He seems very committed to core inflation in spite of the fact that using it helped create the Transitory error.
So we would want core inflation to be coming down, because that’s what we think—core is signaling where headline’s going to go in the future.
Money Supply
I pointed out in a reply to a comment on here last night that the Federal Reserve does not mention the money supply. You can see why below.
The latest US money supply data has revealed that on an annual basis, the M1 money supply has plunged deeper into negative territory, falling to -10.2% in June.
The M2 money supply also continues to see a relatively large YoY decline, which was -3.6% in June. ( @steveanastasioy )
So the brakes are on both in the shorter term and the long term. If we take the numbers literally we see that hitting the inflation target would have the US economy shrinking at an annual rate of 1.6% in 2025. The difference in growth rates is because the extra US $2 trillion or so in M2 is interest bearing deposits. In the latest couple of months M2 has grown a little, but at this stage I would put that down to disintermediation as it is likely to be picking up a type of back flow as funds move to money for the interest-rate.
Remember the Federal Reserve is actively looking to reduce the money supply with this as well.
We are also continuing the process of significantly reducing our securities holdings.
In the last week the US Federal Reserve has sold some US $20.5 billion of its US $7.5 trillion bond holdings ( SOMA). So the heat is on especially as we can expect the Reverse Repo account to shrink as the US Treasury catches up after its borrowing limit stand off.
QT
This was a curious addition to the debate.
Powell: The Fed could continue balance sheet runoff while lowering policy rates under certain circumstances Specifically, policy normalization from restrictive levels to more normal levels (lowering nominal rates to maintain real rates) could allow for QT to continue ( @NickTimiraos )
So they would be tightening policy ( QT) whilst easing it via lower interest-rates? Whilst that would be better for the Federal Reserve as it would presumably be selling its bonds at higher prices it is hard to see how this works for the economy as a whole.
A Brick on a piece of elastic
To my mind the Federal Reserve has forgotten how interest-rate rises work. For quite some time very little happens and I think that is the stage that we are now in. In fact I think that the situation may have got worse for central banks in this regard. We haave looked previously at how many US home owners have long-term fixed rate mortgages. So whilst new buyers will be affected by mortgage rates of the order of 7% existing ones will only be affected if they need to renew which is a relatively small number.
Next up is a change for business behaviour too.
Fed hikes not hurting corporates (as a whole) who termed out and locked in low rates whilest the Fed ran things way too easy for too long during 2020/21 Similar to housing, aggregate picture: less rate sensitive
(but those who were not lucky enough to lock-in will be hurting) ( @Callum_Thomas )
There is a particular irony in this being a consequence of past Federal Reserve policy and if I may be so bold, why I warned that there were more risks than immediately apparent.
Comment
If you take the words of Chair Powell literally you could make a case for 6% interest-rates in the United States. But to my mind there are two major problems with that. First is the reliance on core inflation as a signal after its failures.After such a rise in energy costs there was always going to be a catch-up of sorts in other areas. But more to my mind is the issue of the brick on a piece of elastic which will be along and as I have pointed out there are good reasons to believe the piece of elastic has got longer in modern times. Which means it will hit even harder when it arrives.
So presumably they will then be panicking to cut interest-rates and thus creating the sort of economic instability hey are paid to stop! The brakes are on and it would have been more sensible to wait for more evidence. In a way the US Dollar summed it up as it weakened meaning markets do not believe the plan/rhetoric either.