This article by Lisa Abramowicz, a very good financial reporter who I would recommend following, appeared in Bloomberg’s opinion section. In it she argues that the Federal Reserve’s
Higher risk assets are sending a concerning message to the Federal Reserve: the central bank either needs move more quickly and aggressively to tighten monetary policy, or the fallout from impendinginterest-rate increases will get even worse. As troubling as that sounds, consider that either way it’s looking less likely that the world’s most important central bank will be able to keep the economy from a dreaded hard landing.
Meaning a Fed-induced recession, as opposed a “soft-landing” where economic growth and inflation are slowed gradually over time and without disrupting both the economy and the markets.
Rates traders have now priced in six rate hikes from the Fed before year-end. U.S. stocks have had a bumpy ride, with the once highflying Nasdaq Composite Index down 15.6% from its high in November. Such well-known companies as Netflix Inc., Meta Platforms Inc. and Zoom Video Communications Inc. have fallen even harder, dropping some 40% or more over the past three months.
Corporate bonds have now started to sell off, with yields on U.S. investment-grade bonds rising to the highest since July 2020 relative to those on U.S. Treasuries. The good news – at least for now – is that speculative grade companies are having little trouble borrowing despite six straight weeks of outflows from high-yield, high-risk funds. This suggests that bond investors are not staging a “buyer’s strike” that would threaten to bring the all-important credit markets to a standstill.
U.S. government debt [i.e. bonds], though, rallied last week amid a buildup of troops by Russia along the border with Ukraine. Yields declined and the number of expected rate hikes eased a bit even though the escalating conflict stands to support recent inflationary trends. That’s because any altercation would likely interrupt oil supplies, making a tight European energy market even tighter and sending crude prices higher globally. To be clear, such a scenario would not encourage the Fed to hold off on raising rates; quite the opposite.
Higher energy prices = higher inflation.
At the same time, inflation data have come in surprisingly hot. After the most recent consumer price index report showed a 7.5% rise in January from a year earlier, last week’s producer price index reading also surprised to the upside, jumping 9.7% versus the expected 9.1% increase. Although consumer sentiment has deteriorated, Americans are still spending money at a torrid pace, as evidenced by the surprisingly robust January retail sales numbers and earnings from Gucci owner Kering SA to Walmart Inc. Housing rents are surging, and demand to buy homes still outstrips supply, despite the fact that mortgage rates have risen to the highest levels since 2019.
It’s panic-buying pure and simple. Consumers are spending like crazy because they expect prices to be even higher going forward.
In a nutshell, financial conditions haven’t tightened enough to curb inflation. And it’s unlikely credit-market rates that are still far below historic averages and the current selloff in stocks are enough to restrain consumer demand and corporate activity in the coming months.
There are two possibilities going forward, and both are daunting. Either the Fed needs to take more drastic steps to undermine market resilience, or stocks and corporate bonds haven’t even begun to price in a new Fed paradigm. A third possibility does exist around the idea – which Fed officials are hoping for – that inflation slows naturally. But there isn’t much data supporting such a thing happening, as the latest reading on retail sales for January showed.
There was a great deal of optimism earlier this year that the Fed could engineer a soft economic landing. That possibility is looking more remote by the day.
The idea of inflation slowing naturally is centered on the hope that this inflation we’re experiencing now is being caused entirely by the supply chain shortages, rather than the massive increase to the money supply we have seen since March 2020.
While certainly supply chain shortages are not helping matters, the main culprit behind inflation is the $6 trillion that has been injected into the economy.
Milton Friedman back in 1978 explained that the government is the only entity that can create inflation–because the government is the only entity with a printing press:
I may not agree with Friedman on everything (mainly I take issues with his stances on free trade), but on this point he is absolutely correct: only government can cause inflation.
This is because real inflation is the dilution of the money supply, which causes a permanent rise in prices. This permanent rise in prices is based solely on the fact that the value of a dollar has gone down.
When oil prices go up, certainly that means that consumer price index will go up indicating inflation. But oil prices can also go down, too, and thus the higher gas prices caused by higher oil prices are temporary.
If you increase the money supply, though, that means the value of a dollar is permanently decreased–at least until the money supply contracts. Increased government spending fueled by deficits and money printing will lead to inflation without fail.
It is a fundamental law of economics, and it cannot be changed. We could give every American one million dollars right this very second and it would only make us “richer” for a short time before massive inflation kicked in and a million dollars became the new $50,000 or something like that.
It is a simple matter of supply and demand, and money is very much subject to the law of supply and demand. When the growth of the money supply outstrips the growth of the economy itself (i.e. demand for goods and services), you get inflation.
We are now in this country heading toward the dreaded wage-price spiral of inflation, whereby wages must increase to offset the rising costs of consumer goods, but then corporations can only afford to pay higher wages by increasing prices on their goods and services, and these higher consumer prices thus lead workers (who are also consumers) to demand higher wages in response.
The dreaded wage-price spiral is when prices go up because wages go up, and wages go up because prices go up. It’s self-reinforcing cycle and it has already begun here in the US.
But the reason prices start going up in the first place is because of government-induced inflation. This is what kicks off the wage-price spiral. Wages are increased in response to the rising cost of living.