“Greatly concerned” that inflation “will not be temporary”.
By Wolf Richter for WOLF STREET.
The 10-year Treasury yield has jumped to 1.66% so far, the highest since mid-May, after Christopher Waller – President Trump’s December appointment to the Federal Reserve Board of Governors – said in a speech today: “If monthly impressions of inflation continue to rise to a high level through the end of the year, a more aggressive policy response than a simple cut may well be warranted in 2022.”
Waller supports the Fed’s reduction in asset purchases “following our November meeting,” but this whole thing about “a more aggressive policy response than just cutting” in 2022 – he put a rhythm on the table. faster rate cut and hike that would come sooner in 2022 – shook some nerves in the bond land.
QE was specifically designed to lower long-term yields, such as the benchmark 10-year Treasury yield and mortgage rates; and he succeeded superbly. The reduction in QE will remove a massive buying force – the relentless supply -om the market. And the market is playing with these prospects.
On the short end of the Treasury spectrum – one month to one year yields – little has changed, all below 0.11% today, effectively controlled by the Fed’s grip on that end market through its policy rates and trading activities, including the target range for the fed funds rate of 0% to 0.25%, its repo rate of 0.25%, its repo rate reversed 0.05% – implemented in April to keep short-term yields from falling below 0% – and its excess reserve interest (IOER) from 0.15%.
But the 2-year yield doubled over the past month to 0.41% today, and last week was the highest since March 2020.
Mr. Waller, the new Fed man, carefully reiterated his boss’s official line that inflation may be temporary and could settle down to 2% on its own one way or another. , then tried to shred that line.
He is “very concerned about the upside risk that high inflation will not turn out to be temporary,” he said. And he said:
“The bottlenecks have been worse and outlasting me and most forecasters expected, and an important question that no one knows the answer to is how long these supply issues will persist.
“Through our business contacts, we continue to hear stories about bottlenecks at almost all stages of production and distribution, for example, factories that close due to a shortage of one or more. several essential inputs; a poor cotton harvest in the United States due to the weather which drives up prices; and clogged ports and truck driver shortages.
“Meanwhile, the pay gains have been significant. It apparently hasn’t made its way into prices yet, but how long before it becomes a factor in inflation?
“Businesses report that they have more pricing power now than they have had in many years, as consumers seem to accept higher prices.
“The simple answer is that I think the next few months will be crucial in understanding whether the high inflation rates last and whether that will trigger a lasting effect on the US economy. “
While he was at the shredder, he also shredded some of the oft-cited inflation metrics that make inflation appear lower by removing food, energy and outliers – vehicle price spikes from used or gasoline or new vehicles or other.
He specifically highlighted “basic” inflation measures that exclude food and energy; and the Cleveland Fed’s “truncated average CPI” and the Dallas Fed’s “truncated average PCE” index, which eliminates outliers.
“One way to manipulate data,” he called these efforts.
The problem with removing outliers is that price spikes can change from product to product – Whac-A-Mole’s game, as I’ve called it since June. Whenever an index removes an “outlier”, when in fact it is one outlier after another, rotating in the basket of goods and services, and in fact, they are not at all. outliers, but indicators of high inflation.
By removing food and energy and outliers, “we may be made to ‘skew’ out certain price movements and risk being misled as to the true rate of inflation,” he said. . hawk, hawk, hawk
“We need to keep our eyes open to inflationary pressures, wherever they come from, with consistency and rigor, and be prepared to adjust policy if we conclude that such a change is warranted,” he said. hawk, hawk, hawk.
“If my upside risk for inflation materializes, with inflation considerably above 2% until 2022, then I will favor the take-off [of policy interest rates] sooner than I think now, ”he said.
Accelerating the pace of the reduction “would provide leeway in 2022 to act sooner than expected to start raising the target range for the federal funds rate,” he said. hawk, hawk, hawk.
“A major consideration will be my judgment as to whether inflation expectations are likely to become ‘unanchored’ – rising substantially and persistently above 2%,” he said.
They have of course, as he noted, already exceeded 2%. The New York Fed’s own index of median one-year consumer inflation expectations jumped to 5.3% in September (red line), and three-year inflation expectations jumped to 4.2 % (green line), the embodiment of “not anchored”:
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