With so much dissension and disagreement in the Federal Open Market Committee (FOMC), the minutes of recent meetings have become more revealing. The minutes from the December Fed meeting shed more light on the character of those disagreements than Powell was willing or able to share at the press conference. During that press conference, Powell emphasized consensus amid uncertainty and portrayed disagreement within the Fed as a natural consequence of a multidimensional policy environment. Read alongside those remarks, the minutes reveal a more fractious narrative, one marked by deep and structural differences that are likely to shape monetary policy well into 2026. Powell framed disagreement as technical. The minutes suggest it is structural.

A Committee Without An Anchor

As a reminder, the FOMC members displayed striking dispersion with their votes. While the nine votes in favor of a 1/4 percentage rate cut were sufficient to carry the decision, the minutes indicated that a few of the yes votes came from FOMC members who “indicated that the decision was finely balanced or that they could have supported keeping the target range unchanged”. Two votes opposed the rate cut outright and wanted to leave rates unchanged. The third opposing vote wanted a 1/2 percentage point cut. Specifically, in favor were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Susan M. Collins; Lisa D. Cook; Philip N. Jefferson; Alberto G. Musalem; and Christopher J. Waller. Stephen I. Miran wanted the deeper cut. Austan D. Goolsbee and Jeffrey R. Schmid wanted no change.

Powell’s Consensus Narrative vs. the Reality in the Minutes

Powell framed the lack of unanimity as a question of risk-weighting rather than disagreement over fundamentals. “Everyone around the table agrees that inflation is too high and that we want it to come down,” he said, adding that officials also agree the labor market has softened. Where views diverge, Powell claimed, is “how do you weight those risks and what does your forecast look like,” describing the decision as a “close call” driven by the “complicated, unusual, difficult situation” tugging on the Fed’s dual mandates. Powell’s claim about inflation attitudes is particularly important given the Fed will likely spend a lot of time talking up its inflation-fighting credibility even as it cuts rates this year due to political and economic pressures.

The minutes suggest that the tension is forcing the Fed to confront a confluence of opposing economic views that resists clean consensus and raises the odds of persistent dissension. Importantly, a tension between inflation rhetoric and employment risk runs through the minutes.

Inflation: Confidence in Theory, Unease in Practice

Powell expressed confidence that inflation will continue to move lower over time. In aggregate, the minutes reflect that view. However, “a majority of participants remarked that overall inflation had been above target for some time and had not moved closer to the 2 percent objective over the past year”. The Fed’s staff reinforced these concerns by concluding that the upside risk to inflation has become more precarious given that inflation has remained above the Fed’s 2% target for four straight years. Still, some participants claimed that those upside risks have declined.

In a likely reference to the Fed’s Beige Book (which in 2025 was full of vivid descriptions of inflation pressures), the minutes reported that “some participants stated that their business contacts had reported persistent input cost pressures unrelated to tariffs”. Several of these participants in turn reported that “weaker demand limited the ability of some firms to raise prices or that business productivity gains might enable some firms to manage these cost pressures”. 

The minutes reported that “some participants highlighted the risk that elevated inflation might prove more persistent than expected”. These fears likely stem from the lingering and uncomfortable uncertainty about the ultimate impact of a fluid tariff regime. The minutes reported that a majority of participants expected disinflation in housing services to continue while a few participants also saw ongoing disinflation in core nonhousing services. As usual, this suggests the Fed finds plenty of comfort in the relatively tame long-term expectations for inflation based on survey and market data. As usual, these assessments suggest the Fed finds plenty of comfort in relatively tame long-term inflation expectations based on survey and market data.

If inflation will actually making a soft landing to the Fed’s 2% target in 2027 and 2028 as the current central tendency in the projections insists, the journey will likely continue to feature sticky inflation… and plenty of jawboning to convince financial markets the Fed will not allow tariffs, for example, to cascade into persistently high inflation. According to the minutes, “some participants noted concerns that a more prolonged period of above-target inflation could risk an increase in longer-run expectations”. Four years already seems like a prolonged period, so I am not convinced that a few more years above 2% will dissuade the Fed from continuing to cut rates to try to address weakness in the labor market.

Taken together, the minutes show a Fed that is far more concerned about labor-market fragility than its public messaging suggests. By incorporating that calculus, the bar for another rate cut looks lower than current market pricing implies”.

Labor Markets: Where the Fed’s Anxiety Really Shows

The FOMC sounded more unified about the employment picture. As a result, I expect in due time the Fed will give sway to cutting rates again sooner than later, as soon as January. According to the CME’s FedWatch tool, the current odds for a rate cut sit at a paltry 15% for the January 28th meeting, so I realize my perspective is an outlier. However, in a coming year that should deliver its share of outlier events, I think a January rate cut will be the least of the economic and financial surprises.

In December’s press conference, Powell acknowledged labor market softening. Powell said the Committee agreed that “the labor market has softened” and emphasized that employment faced “further risk”. However, he downplayed the urgency of the perceived deterioration. By contrast, the minutes uncovered some deeper anxieties about the employment picture and now give me further reason to believe in the high possibility for a January rate cut. For example, the minutes reported that several participants presented a case of potential signals of “greater fragility in the labor market”.

Why I am Expecting a January Rate Cut

The minutes reported that “participants generally assessed that, under appropriate monetary policy, the labor market likely would stabilize next year.” This conditional framing supports my expectation for more rate cuts than the market currently assumes. Notably, the central tendency of the Fed’s projections pegs 2025 as the peak year for unemployment. Any negative divergence from that assumption would strengthen the case for additional rate cuts.

Conclusion

The Fed as a group positions its statements for downside risks to employment and upside risks to inflation. However, the balance of its attention suggests the Fed is prepared to act as though inflation is well under control and employment is the more fragile component of the economic picture. I assume the stock market’s complete comfort with the current tensions comes from an abiding belief in the lower trajectory for interest rates. The market has already been gifted three rate cuts with the indices at or near all-time highs. The central tendency for rates in 2026 is 2.9% to 3.6%. The non-zero possibility that the Fed does not cut rates at all this year looks to me like window dressing meant to preserve the Fed’s inflation-fighting credibility.

I am betting on rate cuts to continue in January and an still positioned in the Goldman Sachs Access Inflation Protected USD Bond ETF (GTIP) as a main hedge against the stagflationary potential for more rate cuts in the face of sticky inflation. GTIP currently yields 4.2% and gained 1.9% in 2025. GTIP is down about 17% from its 2021 all-time high.

Be careful out there!

Full disclosure: long GTIP

The post Lessons from the Fed Minutes: Why Division and Dissension Are Likely to Dominate Monetary Policy in 2026 appeared first on Inflation Watch.

The key trigger word was “any.” The first question from the press zoomed directly on the insertion of “any” in the following section of the Fed’s policy statement (emphasis mine):

“In determining the extent of any additional policy firming that may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

Powell’s response essentially confirmed that the Fed thinks it is done fighting inflation with rate hikes. The Fed is so confident that it is now considering how to conduct a rate easing cycle.

“We added the word ‘any’ as an acknowledgement that we believe that we are likely at or near the peak rate for this cycle. Participants didn’t write down additional hikes that we believe are likely…but participants didn’t want to take the possibility of further hikes off the table.”

The last part about keeping rate hikes on the table is just obligatory caution that in name keeps the Fed’s options open just in case.

The next question came from Governor Chris Waller’s claim that the Fed could be cutting rates in the next several months if inflation continued to fall. Powell of course did not respond directly to the commentary, but he affirmed that the Fed has its mind on rate cuts for 2024:

“…the other question of when will it become appropriate to begin dialing back the amount of policy restraint in place that begins to come into view and is clearly a topic of discussion out in the world and and also a discussion for us at our meeting today.”

Note Powell conditioned his remarks to say that “no one is declaring victory, that would be premature.” But again, this is obligatory caution. Victory is practically oozing out of every pore of this meeting. The Fed has to take small and methodical steps in its march to victory.

Inflation Is Dead

Powell’s most revealing answer came to a question about what motivates the Fed to consider rate cuts:

“Both headline and core [inflation] have come down really significantly in three months, that’s a big piece of this. At the same time growth has turned out to be very strong in the third quarter is slowing we believe as appropriate, and we’ve got we’ve had several labor market reports which suggest again significant progress toward greater balance across a very a broad range of indicators. You’re seeing so many of the indicators come back to normal.”

Importantly, Powell noted later in the Q&A that the Fed has seen progress in the most worrisome component of the inflation basket: non-housing services. Now, all three components of core inflation are contributing to inflation’s demise.

Powell further stated that a rate hike is no longer the base case unlike 60 or 90 days ago. He pointed to individual board members who have assessments about the timing for reducing tight policy when saying “that is a discussion we’ll be having going forward.”

Notably, while Powell insisted the job remains to get inflation down to 2%, he acknowledged in response to a reminder about statements in July that the Fed cannot wait until 2% inflation to start cutting rates:

“The reason you wouldn’t wait to get the 2% to cut rates is that policy would be it would be too late. You’d want to be reducing restriction on the economy well before 2% so you don’t overshoot…you know it takes a while for policy to get into the economy and affect inflation.”

Financial Markets Are Ready for Rate Cuts Sooner Than Later

At one point recently, financial markets pessimistically rolled back the first rate cut to September, 2024. Going into this meeting, the market planted the flag on a March rate cut but retreated the day before in the wake of November CPI data. At the time of writing, the first rate cut is firmly rooted in March (source: CME FedWatch) – follow the blue colored boxes for the most likely scenario for a given interest rate policy (labeled across the top of the chart) and a given meeting date (labelled across the left side of the chart).

The comparison chart below shows how the odds for a March rate cut were 39.7% yesterday but 54% a week ago. A month ago the odds were a mere 10.5%. Market opinion has changed rapidly!

Conclusion

In the end, Inflation Watch will stay on the case. The situation remains uncertain and the citizenry are still not happy about prices. Powell admitted as much:

“The price level is not coming down…so people are still living with high prices and that’s something people don’t like. Real wages are now positive so that wages are now moving up more than inflation. As inflation comes down that might help improve the mood of people.”

So while the Fed keeps working, and wages keep trying to outpace inflation, Inflation Watch will keep on watching and reporting!

In the meantime, see below the dramatic impact of the Fed’s declaration of victory on the U.S. dollar (DXY); the recent downtrend looks ready to resume (source: TradingVIew.com).

Full disclosure: long and short U.S. currency pairs

The post The Federal Reserve Makes It Official: Inflation Is Dead appeared first on Inflation Watch.

Don’t Come Crying to the Fed Anytime Soon

Bostic definitively stated that the Fed is so determined to press against inflation that it will likely turn a deaf ear to those who will ask for easier monetary conditions the moment the labor market delivers bad news. Emphasis mine:

“You know, as we get further into inflation getting, closer to our target, I’m expecting we’re going to see stresses in labor markets. We’ve not really seen that. And when that starts to happen, people are going to be looking to us to try to do something about that as well, and maybe turn away from our focus on inflation. But we can’t do that, because failing in getting the inflation back to the 2% target will be much more problematic for the economy. And so as people start to call out for action to provide relief in labor markets, I think what we’re going to have to do is just stay laser focused on the fact that, you know, our employment mandate goal, we are very, very close to that right now. And we’re not close to that in inflation. So we have to stay focused on inflation.”

The bad news for the labor market has been long anticipated and stubbornly absent for the people who keep expecting a recession at every turn of the calendar. This “lagging indicator” of economic health just keeps chugging along. Even a recent uptick in initial unemployment claims above 240,000 fizzled out before the “I told you so’s” could drape the economic headlines. The 251,000 in weekly initial claims from January, 2022 stands as the latest high. For now, initial claims continues to tell the same message week after week after week: the Fed has room to hike if inflation remains an issue. Rate cuts are certainly nowhere on the horizon from this vantage point.

Source: U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis; May 25, 2023.

Given this data and Bostic’s determination to ignore anyone who wants the Fed to cut rates into an inflationary environment, I understand Bostic’s best guess target for rate cuts set a year or more out from now.

“My best case is that we won’t be thinking about a cut until well into 2024. And, you know, inflation is just double what our target is by just about every measure. I don’t see scenarios where the economy is going to evolve in a way such that inflation gets close enough to our target where we might contemplate any kind of cut.”

As of the time of writing, Fed fund futures have acquiesced to the likelihood of another rate hike by July. However, they still eagerly anticipate rate cuts as soon as November. By the time Bostic guesses the Fed will think about cuts, the futures think the Fed will have 6 or 7 rate cuts in the books. The persistently wide gulf between Fed and market expectations on rate policy remains one of the more remarkable features of today’s financial markets.

Fresh Wind for the U.S. Dollar

The market’s push for another rate hike by July has helped the U.S. dollar regain momentum. Strength particularly against the euro and the Japanese yen has the dollar index (DXY) bouncing off its lows for the year. I am riding this momentum as long as it holds up. If the rally continues from here, I expect fresh resistance at the year’s high which should also coincide at the time with critical resistance from the 200-day moving average (DMA) (the bluish line below).

Source: TradingView.com

Be careful out there!

Full disclosure: net long the U.S. dollar

The post Fed’s Bostic: Still Comfortable Leaning Into Tight Labor Markets appeared first on Inflation Watch.

• Starting in 2019: The Federal Reserve warned Silicon Valley Bank about risks in the bank.
• 2021: “The Fed identified significant vulnerabilities in the bank’s containment of risk, but the bank did not rectify the weaknesses.” Ironically enough, one of the six fines issued to SVB included “a note on the bank’s failure to retain enough accessible cash for a potential downturn.”
• July, 2022: a full supervisory review revealed the bank as “deficient for governance and controls.”
• Fall 2022: the Federal Reserve of San Francisco met with “top officials at the bank to address the lack of accessible cash and the potential risks posed by rising interest rates.”

In other words, tight monetary policy was not the root problem of the bank’s problems. Tighter monetary conditions finally forced the issue of disciplining the bank. Tighter monetary policy is supposed to mop up excesses in the economy, and Silicon Valley Bank is starting to look like yet one more egregious example of the excess enabled by the prior era of easy money. It will be interesting to see whether the Fed’s review of its regulatory supervision includes claims that it lacked the authority to force SVB to change its ways.

The Fed Gives Us What We Want

Regardless, as I continue to see blame heaped on the Fed for this latest episode of financial instability, I have surprisingly adopted a more sympathetic view of the Fed’s work. The Federal Reserve has a near impossible job. It seems every major change in monetary policy sets the seeds for the next financial drama. Every financial drama raises the Fed’s prominence yet higher as a centralized economic planner, never able to return to the background of a free market. The Fed now must constantly tinker with interest rates with no clear terminal point. In particular, the economy has set up the Fed to bias towards keeping monetary policy as accommodative as possible for as long as possible. The Fed gives us what we want: policy that supports higher asset prices from stocks to real estate.

The index of financial conditions, as measured by the National Financial Conditions Index (NFCI), since the Great Financial Crisis (GFC) shows extended periods of very easy financial conditions. It is remarkable how little time the economy has been stuck with a positive index, or even a component on the positive side of danger…even in the aftermath of the economic shutdowns from the pandemic.

The Fed’s balance sheet is an even better example of how the Fed gives us what we want in the form of accommodative monetary policy. The Fed was never able to reduce its balance sheet after the GFC. The current tightening cycle barely put a dent in the Fed’s balance sheet. I have a sneaking suspicion that the Fed will never get its balance sheet back to pre-pandemic levels either. Note how the balance sheet ticked up as of last Wednesday in the wake of the rescue programs rolled out to backstop failing banks.

Board of Governors of the Federal Reserve System (US), Assets: Total Assets: Total Assets: Wednesday Level [RESPPANWW], retrieved from FRED, Federal Reserve Bank of St. Louis, March 21, 2023.

Before the GFC, this kind of balance sheet expansion was considered unthinkable. Surely, such a growth in the balance sheet would cause dangerous inflation levels. Given the on-going duration and size of this expansion, I am guessing economic theories will slowly but surely normalize the existence of this balance sheet. Yet, the longer this largesse continues, the more the economy will depend on sustaining these high levels. Thus, the economy will remain vulnerable to instability whenever economic conditions force the Fed into tightening policy. (Recall how the previous tightening cycle moved at a snail’s pace but still eventually forced the entry of a “Plunge Protection Team” to put a floor under the stock market).

What We Want Is Not Free

In a July, 2022 interview on Bloomberg’s Odd Lots (starting at the 14:35 point), famous short-seller Jim Chanos presciently claimed (emphasis mine):

“The one thing people are not prepared for is interest rates resetting meaningfully higher…It just hasn’t happened in most investors’ lifetimes…the idea that actually interest rates are not going to be 2 or 3% for the foreseeable future is going to be hard for a lot of investors to deal with. If we go back to what I would think are more reasonable rates based on what we’re seeing in the economy…this market will not be able to handle 5 or 6% 10-year. It just won’t. So many business models that we look at are extremely low return on invested capital because capital has been so plentiful for the past 12 years.”

The subtext here is that the Fed’s bias has been to leave monetary policy as accommodative as possible for as long as possible. Deflation was the great imperative chasing the Fed into monetary corners. The response to the pandemic was the logical conclusion of this policy as the Fed decided it had the luxury to keep driving unemployment ever lower by holding rates lower for longer. The economy appeared to be in another era where liquidity and massive stimulus could be conjured up for free. The pandemic’s inflationary pulse eventually turned the tables. What we want can actually be quite costly.

Thus, the Fed finds itself in a new trap. I feel for the Fed, but I don’t blame them…we prefer easy money…and many eagerly await the Fed getting disciplined back into cooperation by the Panic of 2023. The Fed Fund futures suddenly expect a long string of rate cuts to follow peak rates in May. I sure hope inflation cooperates as well!

Source: CME FedWatch Tool as of March 21, 2023

A Golden Epilogue

Gold received a new burst of life thanks to the Panic of 2023. As soon as the Fed blinks, I expect gold to rally further. I am keeping the buy button close as we go into the next several decisions on monetary policy starting with March’s. The Sprott Physical Gold Trust ETV (PHYS) broke out to an 11-month high. Today’s 2.0% pullback from over-extended price action looks like it is setting up the next buying opportunity.

Source: TradingView.com

Be careful out there!

Full disclosure: long GLD

The post Don’t Blame the Fed: The Fed Gives Us What We Want appeared first on Inflation Watch.

The S&P 500 (SPY) rallied enough to punch through two important resistance levels. The cumulative losses from Jackson Hole are now almost reversed. (Source: TradingView.com)

If not for the stock market’s reaction, I would have interpreted Powell’s speech to land somewhere between hawkish as ever and no new information. In fact, there were several key points from the speech which should have told the market the Fed is as serious as ever about sustaining an extended fight against inflation (the following are direct quotes unless otherwise indicated; particularly important quotes in bold):

• It will take substantially more evidence to give comfort that inflation is actually declining. By any standard, inflation remains much too high.
• So when will inflation come down? I could answer this question by pointing to the inflation forecasts of private-sector forecasters or of FOMC participant…But forecasts have been predicting just such…a decline for more than a year, while inflation has moved stubbornly sideways.
• It seems to me likely that the ultimate level of rates will need to be somewhat higher than thought at the time of the September meeting and Summary of Economic Projections. (a reiteration from the November monetary policy meeting)
• Restoring [supply and demand] balance is likely to require a sustained period of below-trend growth. (another reiteration)
• Despite the tighter policy and slower growth over the past year, we have not seen clear progress on slowing inflation. 
• It is far too early to declare goods inflation vanquished, but if current trends continue, goods prices should begin to exert downward pressure on overall inflation in coming months. (the stock market must have focused on this claim)
• As long as new lease inflation keeps falling, we would expect housing services inflation to begin falling sometime next year. Indeed, a decline in this inflation underlies most forecasts of declining inflation. (in other words, this claim is old news)
• We can see that a significant and persistent labor supply shortfall opened up during the pandemic—a shortfall that appears unlikely to fully close anytime soon. (the stock market clearly did not hear this)
• The labor market, which is especially important for inflation in core services ex housing, shows only tentative signs of rebalancing, and wage growth remains well above levels that would be consistent with 2 percent inflation over time. (in other words the job market is at risk of sustaining high rates of inflation)
• Despite some promising developments, we have a long way to go in restoring price stability.
• It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down. The time for moderating the pace of rate increases may come as soon as the December meeting. (this is another reiteration, but the stock market seemed to treat this as welcome new news)

If the Fed Fund futures market reversed course and priced in lower peak rates, the stock market’s sudden burst of enthusiasm could have made more sense. However, futures speculators just shifted out the peak 5.00%-5.25% range by one meeting, from March, 2023 to May, 2023. The market did move up the schedule for the first rate cut and ended the year at 25 basis points lower. However, note well that during the Q&A Powell reiterated a warning about the market’s expectations for quick rate cuts: “Cutting rates is not something we want to do soon. That is why we’re slowing down.”

Fed Fund futures market peaked rates at the March, 2023 meeting ahead of Powell’s speech (source: CME FedWatch tool)

Fed Fund futures market peaked rates at the May, 2023 meeting after Powell’s speech and moved the first rate cut up by 5 months (source: CME FedWatch tool)

The day’s rally in the stock market is one of those many times to ignore contrary fundamental assessments and pay attention to what the market thinks. If buyers follow through with the 200DMA breakout on the S&P 500, I will assume seasonal tailwinds are in full flight. Absent any shocks, the market could then rally all the way into the Fed’s December 14th pronouncement on monetary policy. That event will give Powell a fresh chance to redirect financial markets if financial conditions loosen up too much by then. Maybe Powell will have to reiterate how the Fed will “keep at it” instead of “staying the course.”

The Q&A of the Brookings Institution session mainly reiterated points from the speech. There were two points that stirred my interest for future reference.

First of all, Powell actually admitted that the housing market was in a bubble. The conditions he described were easily observable at the time: “coming out of the pandemic, rates were very low, people wanted to buy houses, get out of the cities and move to the suburbs. You had a housing bubble. Had prices going up that were very unsustainable levels, and overheating…” However, of course, the Fed did not dare say the “B” word in the middle of the mania. Powell did not offer any thought on whether the bubble could have been moderated by hiking rates sooner…or at least jawbone about the bubble.

Secondly, Powell mentioned one regret from the 2020 policy framework reset that he mentioned almost as a footnote. Powell indicated that he would not repeat the mistake of relying on a long history of low inflation as a basis for making policy. At the reset, Powell communicated that the Fed would not “lift off” (start hiking rates) until it “saw both maximum employment and price stability.” The stock market soared on this news as it correctly interpreted the change as a Fed more tolerant of a higher range in inflation. Powell admitted that commitment “made us under-estimate tail risk.”

I soundly criticized this pronouncement at 2020’s Jackson Hole. While Powell insisted this mistake has nothing to do with today’s inflation, I continue to insist that this commitment made the Fed slow to respond to rising and then realized inflation risks. Members of the Fed have also dismissed the notion that starting rate hikes a little earlier would have made a material difference in the inflation landscape. We will never know the counterfactual of course. Still, I feel somewhat vindicated that the Fed has taken note of its policy mistake (and prior deflationary bias) and learned some lessons.

Be careful out there!

Appendix: Notes from the Q&A session

Wage increases are going to be a core part of the inflation story going forward.

The labor market has a real supply imbalance

For most workers, wage increases are being eaten up by inflation. Need price stability to get real wage increases.

We assumed that the natural rate of unemployment had gone higher during the pandemic. It’s very hard to pin down where it is when there is a massive disruption.

Used to be able to look through supply shocks. But if we have repeated shocks, it changes things. What are the implications if true? Very hard to know the answers. We tend to think things will return to where they were naturally, but that’s not happening.

Need to be humble and skeptical about inflation forecasts for some time, calls for a risk management framework. If you are waiting for actual evidence for inflation coming down, it is possible to over-tighten. Slowing down is a good way of balancing the risks.

Very few professional forecasters have gotten inflation right.

There isn’t any one summary statistic to determine when policy is sufficiently restrictive. We monitor the tightening of financial conditions (which happens based on expectations). We also look at the effect of these conditions on the economy. Look at the entire rate curve. For significantly positive real rates along the entire curve. Forward inflation expectations reflect confidence in the Fed getting inflation down to 2%. Look at exchange rates, asset prices. Put some weight on these things.

How do you know when you can stop shrinking the balance sheet? This has already been described in a document. We’re in an ample reserves regime. General changes will not impact the funds rate. Will allow reserves to decline until somewhat above where we think is scarcity. Hold the balance sheet constant….. The demand for reserves is not stable. It’s a public benefit to have plenty of liquidity.

Question: August, 2020 announced new flexible inflation targeting framework. Anything in that we should be rethinking. Answer: We will do another review in 2026 or 2026. We implemented through guidance of various kinds. Put in strong guidance because there were a lot doubters that we could ever achieve 2%. Neither did we know. One piece of guidance we wouldn’t do again (it doesn’t have anything to do with the inflation we are currently seeing): we wouldn’t lift off until see saw both maximum employment and price stability. It made us under-estimate tail risk. Remember 25 years of low inflation, inflation just didn’t seem likely.

Cutting rates is not something we want to do soon. That is why we’re slowing down.

It’s not reasonable to expect we get back to the labor force participation in 2020 before the pandemic. But I wouldn’t rule it out. It’s been disappoint and surprising how little we’ve gained back.

We have to assume that for now most of the labor force balancing has to come on the demand side. By slowing job growth, not putting people out of work.

At what point do people ask for more wages because they aren’t keeping up with inflation. Don’t know when that happens, but if it does, you’re in trouble. Labor shortage is not going away anytime soon.

Coming out of the pandemic, rates were very low, people wanted to buy houses, get out of the cities and move to the suburbs, You had a housing bubble. Had prices going up that were very unsustainable levels, and overheating, now the housing market is coming out the other side of that. We have a built-up country, we have zoning, it’s hard to get homes built to meet demand

Full disclosure: long SPY call spread

The post Stock Market Loves Powell Moving from “Keep At It” to “Stay the Course” On Fighting Inflation appeared first on Inflation Watch.

Daly’s steadfast perspective is important to remember every time the stock market rallies in anticipation of peak inflation and/or a “Fed pivot.” Indeed, Daly warned that the Fed needs to be prepared for inflation to be more persistent than expected. For context, Daly was one who was unwilling to predict peak inflation ahead of what turned out to be the “CPI shocker” that delivered a surprise of higher core inflation. Part of Daly’s persistence comes from what she and the Fed see as inflation’s greater potential for economic harm than the short-term consequences of normalizing monetary policy. Daly noted that over two years real wages have fallen 9%. She even shared an anecdote of a worker who told her about how he “loses” money when he goes to buy something with his earnings (an anecdote that speaks to nominal wages failing to keep up with nominal increases in prices).

Other interesting nuggets from the interview:

• Rates are probably now around the neutral rate, and the Fed needs to get slightly restrictive.
• The length of time rates stay neutral (or slightly restrictive) is more important than the specific level.
• 50% of today’s inflation is driven by demand (thus justifying the Fed’s desire to get slightly above neutral), 50% from supply.
• Daly refused to take the bait on the question of whether the Fed was purposely trying to induce a recession, trying to force losses on the stock market, or intent on hiking rates until something breaks.
• Daly insisted the Fed is forward-looking and recognizes lagging indicators of inflation.
• Daly pushed back on the notion the Fed needs to coordinate with global central banks. She insisted that the Fed must stick to its domestic dual mandate.

While the signs a few months ago were clear from commodity prices that the Fed’s actions were impacting inflation, the recent strength in oil threatens to rekindle inflation fears from the average person. For example, gas prices look like they are already done declining. The United States Gasoline Fund, LP (UGA) broke out today. UGA looks like it double-bottomed in September.

The recent downtrend in United States Gasoline Fund, LP (UGA) came to an end this week with a powerful breakout above 50 and 200DMA resistance.

Similarly, diversified commodities producer BHP Group (BHP) looks like it is holding a bottom in place since late last year.

BHP Group (BHP) has so far held its lows from a year ago. While upside may be limited, BHP also looks like it is done going down for now.

If these bottoms are indicative of what is ahead, then any soft readings in the near-term inflation numbers could be, well, transitory… (tongue-in-cheek intended!)

Be careful out there!

Full disclosure: long BHP

The post Fed’s Daly: The Market Is Wrong About A Hump in 2023 Fed Rates appeared first on Inflation Watch.

The Fed’s aggressive anti-inflationary posturing is apparently finally having a positive impact on inflation expectations. Source: NY Federal Reserve.

I would caution anyone who wants to declare victory from the return of 3-year-ahead expectations to pre-pandemic levels. Inflation expectations were so well-contained for so many years, it is hard to project the dynamics of going from high to normalized expectations. For example, how long does the Fed need to continue its aggressive posture to maintain this momentum? Moreover, if the 1-year ahead expectation remains predictive, the Fed will have to stay on course tightening policy into 2023 as the Fed Fund Futures currently expect per the CME FedWatch Tool.

The market keeps pushing expectations for peak rates higher and higher in 2023. Suddenly, the market thinks the Fed is on track to reach a 5.0% to 5.25% range but then quickly back down by year-end.

The apparent predictive nature of the 1-year ahead expectation is particularly notable. Both the 1- and 3-year-ahead measures increased steadily a few months into the pandemic. A large gap opened starting in June, 2021 at the same time that the Federal Reserve was convinced that inflation was transitory. The comfortable math of “base effects” allowed the Fed and many others to essentially ignore the soaring inflation expectations. Clearly, the average consumer agreed with me and did not believe the story. Expectations just kept climbing for an entire year. It is only in the last 2 months – in the wake of a Fed that is suddenly consumed with anti-inflation religion – that inflation expectations took a notable downward turn. So while the big drop in August is encouraging, the Fed will likely need to maintain the psychological pressure for some time to keep a lid on expectations.

In turn, this necessary pressure could keep a lid on the stock market for a while. The S&P 500 (SPY) closed the week perfectly testing the line that defines a bear market (a 20% decline from the all-time high). We might have to get accustomed to the index pivoting around or near this important, psychological line.

The press release accompanying the NY Fed’s report included several additional key points indicating the worst of inflationary pressures could be in the rearview mirror if the Fed maintains the pressure.

• Median five-year-ahead inflation expectations declined to 2.0% from 2.3%.
• Median home price expectations declined by 1.4 percentage points to 2.1%. This drop represents a dramatic decline from April’s 6.0% and is the lowest reading since July, 2020.

On the other hand, despite inflationary pressures decreasing and respondents reporting declining access to credit, the NY Fed reported “median household spending growth expectations increased by 1.0 percentage point to 7.8%. The increase was driven by those with a high-school degree or less.” At the same time, respondents reported higher odds of missing a minimum debt payment, households felt better about their current and prospective financial condition. Net-net, these numbers tell me that the Fed’s posturing and policy have managed to bring some relief to pricing pressures without crushing economic expectations. These cross-currents will likely resolve in yet unexpected ways.

Be careful out there!

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