Still, after the dust settles on this meeting, I fully expect the Fed to stay the course with a rate cut in December. Powell’s statements belie a Fed that is both gradually (some reluctantly?) accepting the case for looking through inflationary pressures and getting incrementally more worried about the labor market.

Division Translates Into Balking

Powell acknowledged strong disagreements among the Committee members. He teased a reveal in the upcoming minutes from the meeting, but the Fed vote says plenty. Recent appointee Stephen Miran unsurprisingly wanted a 50 basis point cut in a repeat of his dissent in the September meeting. Kansas City Fed governor Jeffrey R. Schmid delivered a dissent at the other end with a vote for leaving rates unchanged. Thus, it is easy to imagine the Fed currently holds a broad enough range of opinions on the direction for monetary policy to cause a pause in December.

In response to a reporter’s question about division in the Fed, Powell pointed out that Committee members have different forecasts and different levels of risk tolerances which come through in their speeches. Most importantly, Powell revealed that “there is a feeling in some we should wait.” Since there was just one vote for waiting during the latest meeting, I assume Powell referred to waiting instead of cutting in December – a not so subtle hint that the Fed as a group may already prefer not to cut in December.

The Case for A December Cut Still Looms

However, the hesitancy to cut in December directly contradicts Powell’s assessment of the economic situation. Powell noted that the current rate is above the neutral rate (“wherever it is”). Thus, policy is technically restrictive. Importantly, Powell ascribed the cooling in the labor market and the economy to restrictive policy. So if the Fed has truly adopted the mission to focus on addressing the downside risks in the economy, the Fed must stay biased to cut rates. At this point, the Fed will have a very difficult time explaining how it can “stand by” and watch a weakening economy and labor market.

While there remains upside risk to the Fed’s inflation mandate, Powell makes a weaker and weaker case every meeting that the Fed is truly concerned about that risk. He said plenty to indicate that the prospects for inflation are contained and even tame. Here were his main points on inflation:

• Most measures of long-run inflation expectations remain consistent with the Fed’s 2% inflation target.
• Services inflation is coming down
• Higher tariffs are pushing up inflation as one-time increase in the price level (the base case)
• The core PCE (personal consumption expenditures, the Fed’s preferred measure of inflation) without tariffs would be 2.3% or 2.4% without tariffs, not far from the 2% target.
• The tariff-driven increase in goods prices is happening within the longer-term context of goods deflation.

Thus, once the base case of a one-time effect laps the inflation readings, the Fed should be comfortably close to its target.

While Powell reiterated that the Fed is determined to make sure that the inflationary impact of tariffs is indeed a one-time increase in the price level, the overall picture painted by Powell makes inflation look well-contained. The implied upside risk from the uncertainties in tariff policy hardly seem noteworthy in Powell’s updated narrative.

On the other hand, Powell claims there is “no significant deterioration” in the economic data. While Powell pointed out that the downside risks to employment have risen, he did not express any concern for the highly publicized mass layoffs from big companies like Amazon.com (AMZN) and United Parcel Services (UPS). In response to a question about these layoffs, Powell only said that the Fed is watching these developments, and the layoffs do not yet show up in the initial claims data (of course not – these layoffs are recent announcements).

Overall, Powell sums up the labor issue as low hiring and low firing in the context of immigration policies shrinking the labor supply and a cyclical drop in the participation rate in the workforce. When asked how then will rate cuts help the job market, Powell responded that cuts will make sure the “labor market doesn’t get worse.” Upon hearing that explanation, I felt tingles of recessionary risks.

Inflation Warnings from Overseas?

While Americans are mostly focused on the inflation risks from tariffs, inflation is also proving stubbornly sticky in other major economies who are not at war with the global economy. For example, with inflation at 3.8% in the United Kingdom, the Bank of England is further away from its 2% inflation target than the Federal Reserve is from its target. In its last letter explaining the on-going inability to hit the target, the BoE reported:

“The recent increase in CPI inflation has owed largely to food prices and administered prices, including water bills and Vehicle Excise Duty. A reduction in total labour cost growth also appears to have been delayed by the increase in employer National Insurance Contributions (NICs) and pay growth in sectors with a large share of employees at or close to the National Living Wage (NLW).”

Yet, the BoE expects this year’s inflation increase to peak in September. The combination of a weakening labor market and restrictive policy is expected to help push inflation toward the 2% target next year. This is the UK version of hopeful monetary policy. The BoE just made its last rate cut in August, going from 4.25% to 4.0%. The policy rate was left unchanged in the last meeting.

Earlier this week, inflation in Australia hit its highest point in over a year. With inflation now above the Reserve Bank of Australia’s target band of 2-3%, the RBA will likely need to put a pause on its easing cycle. The Australian Bureau of Statistics identified housing, recreation and culture, and transport as the main drivers of inflationary pressures. A likely pause in easing further strengthened my case to stay long the Australian dollar (FXA).

I am now on heightened alert for sticky inflation becoming a global problem that justifies an extended run for the debasement trade.

A Pause in the Debasement Trade

As the Fed expresses hesitancy about cutting rates again in December, the debasement trade took a major pause going into the Fed meeting, perhaps in anticipation of a less dovish Fed. Given I think the Fed will feel compelled to proceed with cuts in December, I consider the pause in the debasement trade to be even more temporary than the inflationary pressure from tariffs. I have treated this sharp pullback as the buying opportunity I have (mostly) patiently waited for. When parabolic rallies finally lose steam, the pullbacks are often swift and steep. I am looking for support to hold for the SPDR Gold Shares (GLD) by the $350 level where the 50-day moving average (DMA) (the red line in the chart below) awaits testing.

Bond yields understandably spiked higher in response to the Fed’s balk on rate cuts. However, I am no longer interested in trying to fade rallies in the iShares 20+ Year Treasury Bond ETF as I now accept that the bond market’s overall trajectory is to worry much more about imminent economic weakness than lingering inflationary pressures.

The bond market is giving the Fed a green light for rate cuts. Thus, today’s balking should gradually transition to acceptance in the coming weeks.

Be careful out there!

Full disclosure: short GLD put, long GLD calendar call spread, long UPS, long AMZN put spread

The post Powell Balks At the Next Step of Hopeful Monetary Policy appeared first on Inflation Watch.

“Inflation has remained stubbornly above the 2% target. Despite subdued pay growth, weak productivity has meant no corresponding fall in domestic cost pressures. And increases in university tuition fees and domestic energy bills, largely resulting from administrative decisions rather than market forces, have added to inflation more recently. CPI inflation is likely to rise further in the near term and may remain above the 2% target for the next two years, in part reflecting a persistent inflationary impact both from administered and regulated prices and the recent decline in sterling. But inflation is expected to fall back to around the target thereafter, as a gradual revival in productivity growth dampens increases in domestic costs and external price pressures fade.”

I took particular interest in the claim that external price pressures will fade. To do so, the global economy would have to remain weak. If so, then it is unlikely that growth in the UK will fare much better, even at the projected “slow but sustained” pace. The other possibility is that the British pound or sterling – CurrencyShares British Pound Sterling Trust (FXB) – appreciates enough that external prices go back down. If so, then Mervyn King’s hopes of rebalancing the economy with a reduction in demand for imports and an increase in exports surely will not be realized.

Adding to this conundrum for the UK economy is the stubborn persistence of weak economic growth (mainly flat) along with strong employment growth. The UK economy is getting less and less productive and thus less and less capable of offsetting inflationary pressures. This is a dynamic that I will be watching ever more closely given the BoE projects a two-year horizon over which the economy will continue to suffer high inflation and weak economic growth (aka stagflation). The implication for the currency is mixed, and I continue to expect “more of the same” for the pound.

The post The UK’s CPI inflation to remain stubbornly high for the next two years appeared first on Inflation Watch.

King begins by acknowledging the squeeze on the current economy:

“The challenge facing monetary policy is obvious – the combination of high consumer price inflation and weak economic growth. Both of these might seem surprising given the large amount of spare capacity in the economy. But the rise in world energy and other commodity prices, and the need to reduce both the external and budget deficits, are squeezing real living standards, pushing up on consumer price inflation and slowing domestic consumption.”

Over the years, King has consistently hammered on the theme of rebalancing in the UK’s economy: a transition away from domestic consumption and toward exports and the business investment required to support this shift. King indicated that the rebalancing underway will continue for several more years. This process has necessitated the devaluation of the currency. Interestingly, King cleverly attributes the devaluation to market forces while indicating the Monetary Policy Committee (MPC) chose not to counter-act the pressures on the currency:

“A necessary precondition for that rebalancing was a fall in the real exchange rate. Markets anticipated that need. The nominal effective sterling exchange rate fell by around 25% between the start of the crisis in 2007 and the beginning of 2009, since when it has been broadly stable…

…We could have raised Bank Rate significantly so that inflation today would be closer to the target. But that would not have prevented the squeeze on living standards arising from higher oil and commodity prices and the measures necessary to reduce our twin deficits. And it would have meant a weaker recovery, or even further falls in output…”

In other words, the MPC decided to focus on the implications of a weak economy over the implications of high inflation, judging the former to be the greater threat. In doing so, King has frequently noted that today’s high inflation is temporary, thus rationalizing on-going accomodative monetary policy and low interest rates in the face of high inflation. The primary blame for high inflation has shifted from hikes in taxes (the Value Added Tax or VAT) to commodity and energy prices, both presumably out of the control of monetary policy. Internally, conditions do not exist for sustaining “domestically generated” inflation:

“So far, subdued rates of increase in average earnings, as well as remarkably – some might say disturbingly – low growth rates of broad money have provided strong signals that inflation will fall back in due course. Banks are still contracting balance sheets and reducing leverage. Spreads between Bank Rate and the interest rates charged to many borrowers remain at unprecedentedly high levels, if indeed borrowers are able to access credit at all.”

King really caught my attention when he provided two key conditions that would actually compel rate hikes:

• A pickup in domestically generated inflation
• A contraction in the spreads between Bank Rate and the interest rates charged to many borrowers

Given the dour outlook for the economy and an on-going reblancing in the economy, I continue to assume that rate hikes in the UK are somewhere off in a very distant future. King has proven quite adapt in coming up with reasons for maintaining loose monetary policy, and I continue to see strong evidence that he is reluctant to tighten for fear it could upset the rebalancing he so deeply desires. Indeed, King notes that there is no way to tell when the MPC may hike rates:

“Uncertainty inevitably surrounds both the speed of the rebalancing and the impact of today’s consumer price inflation on tomorrow’s domestically generated inflation. So it is simply impossible to know now at what point monetary tightening will begin.”

The post Bank of England Governor King continues to bet on inflation taking care of itself appeared first on Inflation Watch.

“We clearly need to keep inflation at bay…Too much inflation is not going to be conducive to growth.”

While these conclusions are obvious, the remarkable quality of these comments is that they come at a time when inflation remains a concern amongst developing and emerging economies and not the (relatively) stagnating ones of Europe and the United States.

Only time will tell whether comments like these will translate into any changes in monetary policy anytime soon. For example, Governor Mervyn King made it quite clear this week in his discussion of the Bank of England’s Inflation Report, that he has no intention of changing monetary policy anytime soon even with inflation continuing to print well above the Bank’s mandated target of 2%.

The post France joins a growing group of nations concerned about inflation appeared first on Inflation Watch.

The interviewer reminded Posen that the BoE was wrong about its inflation forecast going into 2007, and Posen accordingly refused to get nailed down on any timeline for a rate hike. He did note that if there is no clear inflation shock in the economy, then the BoE will have to assume that inflation expectations are too high.

The post High inflation in the UK worries the BoE, but preferred to deflation appeared first on Inflation Watch.

The Bank of England continues to expect a “…a slow recovery in the level of economic activity” partially because “…it is likely that credit conditions will remain restrictive for some time and that the need to strengthen public and private sector finances will weigh on spending.”

Moreover, the BoE maintained its forecast for low inflation for the next three years claiming that “…it is more likely than not that inflation will be below the target [2%] for much of the forecast period, but the risks are broadly balanced by the end.” (The forecast ranges from -1% to 5%).

Given these conditions, the Bank of England will be in no rush to tighten (significantly) monetary policy anytime soon.

The post Bank of England sets stage for maintaining easy monetary policy appeared first on Inflation Watch.