As expected, the Federal Reserve’s policymaking body, the Federal Open Market Committee (FOMC), voted to raise the benchmark federal funds range along with the various monetary policy tools to accomplish this (IOER, RRP). Increasing each by one-quarter point, Chairman Jay Powell and the Fed’s other committee members are trying to send a message to the public that the nation’s nominal central bank is on the case.
For an entire year now, consumers have been plagued by rising prices. In the most recent months, the pain of paying more has been concentrated in modern life’s basic essentials: food, fuel, and shelter. The last CPI estimation, released last week for the month of February 2022, showed the average consumer paying almost 8 percent more last month for all manner of goods than they had the prior February.
This was the highest CPI increase in just over forty years. And more than half of it was caused by the visible, visceral jump in the costs of gasoline, groceries, and rent.
Since this accelerating trend in consumer prices began around March 2021, the public has correctly connected it with the heavy U.S. government interventions that took place around that time—basically, Uncle Sam, who had already been shoveling cash to businesses (“loans” that have since been changed into grants) as well as citizens, then upped the doses for both.
The question, or problem if you are Jay Powell and the FOMC, is how might raising the federal funds’ benchmark range put a stop to the rampaging consumer prices the federal government’s intervention had helped unleash?
Those government “helicopter” payments haven’t been repeated, and already there’re plenty of signs consumers have exhausted whatever might have been left from them; demand for goods has been waning overall even if oil prices are detached (somewhat by reaction to what’s happening in Ukraine) from that drawdown.
More to the real point, the Federal Reserve cannot—by rate hikes or any other of its means—extract more crude from the ground to make up for what remains a huge supply imbalance in energy. Nor can it manufacture by FOMC vote the shipping and rail capacities to transport food and grocery items more efficiently and effectively, the primary reason why costs have gone up at the store at the same time many shelves within it have been left intermittently empty.
Instead, policymakers’ intended series of rate hikes, this week’s just the first, are meant purely to send a message to the public at large and consumers, in particular, that they needn’t worry about the harm they’re experiencing. Somehow, some way, you’re left to believe these policy actions will take care of them (just don’t ask how).
Consumers, however, may already be ahead of the curve in terms of understanding real inflation potential. Despite the FOMC’s fixation on recent CPI’s, surveys of consumers from various outlets—including the Fed’s very own—keep showing fewer and less imminent worries about prolonged price pain.
According to the Federal Reserve’s New York branch (FRBNY), its consumer survey has shown two very important diverging (from the FOMC’s policy view) results. First, respondents have expressed lower expectations for the headline CPI rate coming up, therefore a decline in anticipated average consumer price gains since October 2021. Even as each subsequent inflation measure has gone up, short-run CPI expectations have gone the other way.
Second, consumer responses for longer-run expectations have been continuously less than what survey respondents have said they expect in the short run. In other words, overall, consumers don’t believe this “inflation” is going to last beyond it.
This latter view has been found and documented across multiple data sources, including the closely-followed University of Michigan’s Surveys of Consumers. In this latter one, once more we see how longer-term expectations (5 years forward) for the CPI are well below those not so far down the line (1 year forward).
Since each of these divergences predates rate hikes and even the FOMC’s votes on tapering the last quantitative easing program, consumers maintained an aggregate position that this price shock would only be temporary and that its ultimate, perhaps inevitable, end will not be from whatever the Federal Reserve might claim to be doing in response.
It is very likely, even probable, that the public understands on a fundamental level how these kinds of supply shocks, when prices for basic necessities skyrocket, typically end: in the form of something called demand destruction.
At some point, being forced to pay more for non-discretionary items steals away consumers’ ability to spend on everything else. That’s not inflation; it is harmful redistribution that history has shown more often than not ends with recession—and consumer prices calming down quite a lot on their own when that happens.
This is the most reasonable conclusion to draw from other parts of these consumer surveys, including those related to confidence. The University of Michigan’s measure of consumer confidence dropped this month to their lowest indicated levels in over a decade.
It is this downside probability that, even this week with the FOMC’s announcement, is now heavily priced across multiple U.S. credit markets. The U.S. Treasury yield curve had been modestly inverted from the 7-year to 10-year calendar space, and is now slightly more inverted in the same while inversion has spread to include the 5-year maturity.
The eurodollar futures curve (not depicted) had been more deeply inverted than the yield curve, and has since traded even more in its already-pessimistic distortion.
Each of these markets and their ugly inverted curves are pricing closer to certainty over the supply shock and demand destruction scenario, which has been continuously found in those (and other) surveys of consumers—markets matching only too well with the common if largely unreported public perceptions about inflation and economic potential.
In this case, Jay Powell’s Federal Reserve finds itself quite literally behind the curve(s). His institution is making a very public gesture to reassure people he’ll handle an inflationary problem those same people largely believe, markets forcefully backing them up, might already be on its way to being resolved.
Just not at all likely in a good way.
