“Greatly concerned” that inflation “will not prove temporary.”
By Wolf Richter for WOLF STREET.
The 10-year Treasury yield jumped to 1.66% at the moment, the highest since mid-May, after Christopher Waller – President Trump’s December appointment to the Federal Reserve Board of Governors – said in a speech today, “If monthly prints of inflation continue to run high through the remainder of this year, a more aggressive policy response than just tapering may well be warranted in 2022.”
Waller supports tapering the Fed’s asset purchases “following our meeting in November,” but this whole business about “a more aggressive policy response than just tapering” in 2022 – he put on the table are a faster pace of tapering and rate hikes that would come earlier in 2022 – jostled some nerves in bond land.
QE was specifically designed to push down long-term yields, such as the benchmark 10-year Treasury yield and mortgage rates; and it succeeded superbly. Tapering QE is going to remove a massive buying force – the relentless bid – from the market. And the market is toying with those prospects.
At the short end of the Treasury spectrum – from the one-month to one-year yields – not much has changed, all of it below 0.11% today, effectively controlled by the Fed’s grip on that end of the market through its policy rates and trading activities, including the target range for the federal funds rate of 0% to 0.25%, its repo rate of 0.25%, its reverse repo rate of 0.05% – implemented in April to prevent short-term yields from dipping below 0% – and its Interest On Excess Reserves (IOER) of 0.15%.
But the 2-year yield has doubled over the past month to 0.41% today, and for the past week has been the highest since March 2020.
Mr. Waller, the new man at the Fed, carefully repeated the official line of his boss that inflation may be temporary and might settle down at 2% on its own somehow and then went about to shred this line.
He is “greatly concerned about the upside risk that elevated inflation will not prove temporary,” he said. And he said:
“Bottlenecks have been worse and are lasting longer than I and most forecasters expected, and an important question that no one knows the answer to is how long these supply problems will persist.
“Through our business contacts, we continue to hear stories about bottlenecks at almost every stage of production and distribution—for example, plants that shut down because of a shortage of one or more crucial inputs; a poor cotton crop in the United States due to weather, which is driving up prices; and clogged ports and trucker shortages.
“Meanwhile, wage gains have been strong. That apparently has not made its way into prices yet, but how long before it becomes a factor driving inflation?
“Firms are reporting that they have more pricing power now than they have had in many years, as consumers seem to be accepting higher prices.
“The simple answer is that I believe the next few months will be crucial to understanding whether elevated rates of inflation last and if that will trigger a lasting effect on the U.S. economy.”
While at the shredder, he also shredded some of the often-cited inflation measures that make inflation appear lower by stripping out food, energy, and the outliers – the price spikes in used vehicles or gasoline or new vehicles or whatever.
He specifically pointed at “core” inflation measures that strip out food and energy; and at the “trimmed mean CPI” by the Cleveland Fed and the “trimmed mean PCE” index by the Dallas Fed that strip out any outliers.
“A way of manipulating the data,” he called these efforts.
The problem with removing the outliers is that the price spikes may be rotating from product to product – the game of Whac-A-Mole, as I’ve been calling it since June. Each time an index removes a different “outlier,” when in fact, it’s one outlier after another, rotating through the basket of goods and services, and in fact, they’re not outliers at all, but signposts of high inflation.
By removing food and energy and the outliers, “we may be led to ‘falsely’ dismiss certain price movements and risk being misled as to the true inflation rate,” he said. Hawkish, hawkish, hawkish
“We must keep our eyes open to inflationary pressures, wherever they come from, with consistency and rigor and stand ready to adjust policy if we conclude that such a change is warranted,” he said. Hawkish, hawkish, hawkish.
“If my upside risk for inflation comes to pass, with inflation considerably above 2 percent well into 2022, then I will favor liftoff [of policy interest rates] sooner than I now anticipate,” he said.
Speeding up the pace of tapering “would provide policy space in 2022 to act sooner than now anticipated to begin raising the target range for the federal funds rate,” he said. Hawkish, hawkish, hawkish.
“A major consideration will be my judgment about whether inflation expectations are at risk of becoming ‘unanchored’ – rising substantially and persistently above 2 percent,” he said.
They have of course, as he noted, already shot way above 2%. The New York Fed’s own index of consumers’ median inflation expectations for one year from now jumped to 5.3% in September (red line), and inflation expectations for three years from now jumped to 4.2% (green line), the embodiment of “unanchored”:
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