It’s like a dam broke. And now higher interest rates and mortgage rates for much longer, with lower asset prices, as the Everything Bubble gets repriced.
By Wolf Richter. This is the transcript of my podcast recorded last Sunday, THE WOLF STREET REPORT.
So now the media suddenly focuses on this big problem I’ve been screaming about for many months: Inflation has shifted from energy and from goods tangled up in supply-chain issues to services where there are no supply chain issues.
A great example is insurance. I guarantee you that there is an unlimited supply of insurance, and yet health insurance costs spiked by 24% over the 12-month period, and auto insurance jumped by 9%.
It’s small stuff too. I just got a 20% increase on my broadband service that I subscribed to a year ago to replace Comcast, which had doubled its monthly fee a year earlier.
Other service prices jumped too. Motor-vehicle maintenance and repair jumped 9%, and rents are spiking, and all kinds of service providers are jacking up their prices, and consumers are paying them.
That’s services inflation. And most of it is unrelated to energy and supply chains.
Yet gasoline prices have plunged from their highs in June, and many supply-chain issues that drove up prices of some goods have been resolved, and lots of commodities prices have come way down.
So now we’re dealing with inflation in services. This type of inflation means that something has seriously changed in the economy, and how the participants in that economy – so that’s consumers, businesses, and governments – are reacting to price increases. And how they’re reacting is that they’re paying those price increases.
Businesses are paying them because they know they can pass them on to their customers. Consumers are paying them, because they’re getting raises, and they’re still flush with cash from all the pandemic money, from the PPP loans, the mortgage payments and rental payments they didn’t have to make, and from the gains in real estate and from the cash-out refis last year, and from the gains in stocks and cryptos, though those gains have started to dissipate.
And governments at all levels sit on huge amounts of pandemic-era cash, and this cash is getting spent, and so wholesale prices go up and businesses pay them, and consumer prices go up, and people pay them. And it happened suddenly, starting nearly two years ago.
For many years, central banks have engaged in massive amounts of money printing and interest rate repression. The Bank of Japan started this over two decades ago, and it bought up a big portion of the government’s debt, and it repressed interest rates to zero, and in recent years below zero. It got away with it for years, and there was essentially no consumer price inflation.
And then during the Financial Crisis, starting late 2008, the Federal Reserve in the US started printing large amounts of money and it repressed short-term interest rates to zero, in order to bail out the bondholders and stockholders of the banks, and to inflate asset prices in general, to inflate stock prices, and bond prices, and real estate prices. And that didn’t trigger a big wave of consumer price inflation either.
And when the European Central Bank saw that neither the Bank of Japan’s money printing, nor the Federal Reserve’s money printing triggered consumer price inflation, but just asset price inflation, it too jumped into the game and printed huge amounts of money and repressed interest rates to zero, and then below zero.
And central banks of smaller countries were doing it, and just about everyone in the developed world was doing it.
And then came the Pandemic, and so now all these central banks that had been printing money and repressing interest rates without triggering consumer price inflation, went hog-wild, thinking that these many trillions of free money wouldn’t cause inflation either, because it didn’t before. But this time the amounts were a lot huger, and they came very fast.
And governments all around spent many trillions in borrowed money that their central banks were providing via their bond purchases, and all this central-bank monetary stimulus and the governments’ fiscal stimulus washed over the globe, and much of it over the United States economy, and just about everyone here got some of this money, people, businesses, and state and local governments, and they all started spending this money.
This sudden wave of free money caused a historic spike in demand for goods, which triggered the supply chain issues, which triggered the backlogs, the waiting lists, and people were so flush with money that they paid whatever, and prices of goods then spiked. It kicked off with used vehicles where prices spiked like crazy, starting in late 2020.
It was when the dam broke. And inflation began pouring into the United States.
Now the big push in inflation is no longer from goods, and it’s no longer from commodities and energy, and gasoline prices have already plunged as have many commodities. Now the big push is from services.
Inflation has spread across the entire economy, and is deeply entrenched in sectors that have little or nothing to do with energy, commodities, and supply chains.
So what we have here is that the dam that held back inflation for over a decade of money printing and deficit spending suddenly broke, and inflation flooded the country and spread across it, spread from sector to sector, and it’s huge, and more inflation is flooding in. And the original triggers have already started to recede, such as energy and supply chains, and now it’s services and other goods.
This dam that broke cannot just be put back together, so that inflation might just evaporate or whatever.
We haven’t seen this type of inflation in over 40 years. The prior dam that broke was during the oil embargo in the 1970s. And it led to a long and huge flood of inflation, that was ultimately brought back under control, but way too late, by draconian monetary policies, like we cannot even imagine today, with 30-year fixed mortgage rates hitting 18%.
Today we whine about the 6% mortgage rates. Back then, it took mortgage rates that were three times higher than today’s 6% to get this inflation monster under control.
So no, this inflation is not going away on its own. It is self-propagating. It has momentum, it’s cycling from segment to segment, and when prices stabilize or tip in one segment, they’re spiking in another. It’s what I call the game of inflation Whac A Mole.
The Fed has finally figured this out too – over a year too late. But now it’s serious about this inflation.
And here is the thing: with every meeting since last fall, the Fed has gotten hawkisher and hawkisher. All interest rate projections – how many times it might hike rates, how big the hikes might be, and where the hikes might end – moved higher at every meeting.
So now the Fed might go to 4% with its short-term policy rates by the end of this year. It might go to 4.5% by early next year.[Update: at the FOMC meeting this week, a few days after this podcast aired, this was moved up to about 4.4% by the end of this year, and higher next year… read: Powell’s Whatever-it-Takes Moment].
And we now think that the Fed might then pause to see how inflation will react. But inflation keeps getting worse at the core of the economy, namely in services, and so the Fed might not pause at 4.5%, and all bets are essentially off until we see some containment of this inflation at the core of the economy.
The Fed is now also engaging in quantitative tightening or QT, which means it is reversing quantitative easing, which will reverse the effects of quantitative easing, which was the Everything Bubble, where all asset prices shot up together. And this is now being reversed.
The QT program has ramped up to full speed in September. Last week, the Fed stopped buying mortgage-backed securities entirely. And it’s letting its mortgage backed securities run off the balance sheet. By stepping away from the mortgage market, the Fed will no longer repress mortgage rates, and they’re going to go where the market thinks they should go, given that inflation is over 8%. Mortgage rates have already more than doubled from 3% a year ago, to well over 6% now.
The harder and the faster the Fed cracks down by hiking rates and by unloading its balance sheet, the sooner inflation might go back down. But the Fed really hasn’t cracked down yet. It’s still just lowering the amount of fuel it’s pouring on the inflation fire.
The top end of the Fed’s target range for the federal funds rate is currently 2.5% [update: as of Wednesday, it’s 3.25%], and with inflation over 8%, the Fed is still pouring huge amounts of fuel on the fire.
There is a good chance it will hike its target by 75 basis points at its meeting this week [update: it did], which would bring the top end to 3.25%. With CPI inflation at over 8%, it will still be pouring huge amounts of fuel on the fire.
Even if it hikes by a full percentage point, with the top of its range then at 3.5%, it would then still be pouring huge amounts of fuel on the inflation fire.
Interest rates will have to go a lot higher to crack down on inflation. And that includes long-term interest rates, and mortgage rates.
It doesn’t help that government spending, and I mean at all levels of government, is still stimulating the economy and fueling inflation. State and local governments are flush with pandemic money, and they’re going to spend it.
And the federal government is still throwing money around, including for things like incentives for EVs where demand is already red-hot, and prices are already spiking, and there are already long waiting lists to get one, and so now the government is throwing many billions of dollars of stimulus money on top of the already red-hot EV sector. This stuff is just crazy – to stimulate demand in an already red-hot sector with spiking prices.
This is going on all over the place. In other words, this is still a massively stimulated economy, fiscal stimulus, as well as monetary stimulus. And the inflation dam has broken, and new inflation is pouring into the economy.
To get this under control will take a lot of action by the Federal Reserve. Governments are not contributing anything to fighting inflation. On the contrary. They’re lined up stimulating inflation. It’s all on the Fed’s shoulders.
So this inflation isn’t going away any time soon. It has a good chance of getting worse next year. And it’s going to take years to get this under control, years of much higher interest rates, and years of much lower asset prices.
But it also means, years of much higher yields for bond holders and savers that buy those products in the future. Some yields of Treasury securities are already at 4%, such as the one-year Treasury yield. Some one-year CDs are already at 3.5%. Some savings accounts are at around 2%. And they’ll all be going higher as we go forward. But they’re still way below the rate of inflation.
We’re looking at years of much lower home prices, and much lower prices of commercial real estate. The whole entire asset bubble – the everything bubble that had been inflated by years of money printing and interest rate repression – this everything bubble is going to get repriced, and some of it has already gotten partially repriced.
Cryptos are down 70% or so. The overall stock market is down 20%, as tracked by the Wilshire 5000 index as of Friday. The most speculative parts of the stock market are down 70% and 80% and 90% or more, such as the hundreds of stocks that went public via IPO or SPAC over the past two-and-a-half years – my infamous Imploded Stocks.
And it has just started. We’re only a few months into Fed tightening. And the Fed is still way behind the curve. Inflation is now raging at the core of the economy where it is very difficult to dislodge. The many years of easy money are gone, and they’re not coming back any time soon.
I think central banks are now learning a lesson how the combination of money printing and deficit spending are just fine for many years, until suddenly the dam breaks, and inflation floods the economy, when no one expects it anymore, triggering years of a very messy process to bring this back under control.
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