written by
Simon Ree

Things Are About To Get Real For The Fed

economy 1 min read

Inflation came in much hotter than expected, with headline CPI printing at +6.2% from Oct 2020...a 31 year high.

This is teeing-up a massive communications challenge for the Fed.

The bond market is pricing an aggressive policy response with little risk of long term inflation. But this will require a dramatic tightening in policy, well above anything the Fed has communicated. And this would happen just as fiscal supports are rolling off and economic growth measures are moderating/peaking. The stock market would hate this!

The Fed keeps assuring us that inflation is transitory. SF Fed Chair Mary Daly today described inflation as "eye popping" but also said she expects it to moderate and that it would be premature to make any policy changes.

If inflation IS transitory, a significant tightening of policy (like what the bond market is pricing) would likely create a (severe) recession. However if inflation is NOT transitory, waiting too long could open a whole other can of inflationary worms.

The Fed is staring at the most tricky transition it's faced in decades. The days of easy printing without consequence appear to be over. Do they significantly tighten policy as inflation data continues to accelerate? Or do they wait and see...risking an inflation genie that is almost impossible to put back in the bottle? I don’t see a middle path.

As for all the the talk of Powell getting the sack? I think replacing the incumbent Fed chair at this critical juncture would introduce another layer of uncertainty and unnecessary risk.

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