After months of telegraphing that the Federal Reserve would finally slow rate hikes from its breakneck 75-basis-point hikes of the past six monthly meetings, Jerome Powell got the greatest news he could have hoped for on Tuesday. The Bureau of Labor Statistics reported that November’s consumer price index inflation fell to 7.1% on an annual basis, below expert expectations. Coupled with slightly moderating core inflation, the latest CPI report will give the Fed the go-ahead on a smaller rate hike — perhaps just half a basis point.
Will the product of the good news of moderating inflation lead to good consequences? Perhaps not. Core inflation, the Fed’s preferred CPI measure that subtracts the volatile categories, has indeed posted the first two consecutive months of meaningful slowing since the start of this year. But at 6%, it is three times greater than the annual inflation rate targeted by the Fed. Furthermore, if the Fed does indeed slow its rate hike campaign, bringing the federal funds rate to a 4.25% to 4.50% range, it will take even longer for real interest rates to emerge from the red into the black.
INFLATION DROPS TO 7.1% IN LATEST SIGN OF RECOVERY — BUT ‘STILL TOO HIGH‘
Ordinarily, all of this would mean that interest rates are definitely negative. But the Fisher equation, which calculates real interest rates by subtracting the inflation rate from nominal interest rates, does not take into account the Fed’s quantitative tightening scheme — modest in comparison to a decade of quantitative easing, yet unprecedented all the same. The money supply doubled from 2008 until March 2020 and then increased again by one-third from March 2020 until March of this year. After all this tightening, it has contracted by a mere percentage point since this March. But the San Francisco Federal Reserve Bank estimates that QT rendered the real federal funds rate more than a full percentage point higher than nominal rates as of September. Even with a more modest rate hike this month, the SF Fed’s estimate would put real interest rates near 6% or perfectly zero when adjusted for inflation.
This, of course, is an optimistic analysis of the situation and one that would only result in continued inflation abatement, assuming that the Fed will hold fast to Powell’s promise of keeping the interest rate at or above a nominal 5% target for some time. Inflation continues to cost the public thousands of dollars as groceries continue rising by an annual 12% and electricity by 14%. Furthermore, the Fed’s decision to moderate interest rates runs the risk of a double-dip recession or even a hyperinflation spiral that slowly corrodes the greenback while dangerously compounding the interest owed on our national debt.
But Powell has done what he has wanted thus far, with little regard for political implications or popular support. The CPI print only provides further backing for his hopes of navigating a soft landing.
