Author: Mr. X
Talk about mixed messages.
President Joe Biden has had something of a political recovery lately. The Democrats are gaining in Senate races, though the GOP is still favored to take the House. Still, the prospect of a “red wave” looks farther away than at any time over the last year. President Biden hailed the passage of the “Inflation Reduction Act” yesterday at a White House event with thousands of supporters. “This bill cuts costs for families,” he said. That remains to be seen.
The president’s triumph was overwhelmed by the Consumer Price Index figures from August, which showed that inflation persists. In fact, it’s getting worse. Inflation rose 0.1%, when experts were expecting a decline. Year-over-year, the CPI has increased by 8.3%.
The Federal Reserve Bank of Cleveland reported even worse news. Its median Consumer Price Index, which excludes outliers, increased by more than 0.7%, beating the previous record set in June.
The Associated Press rather bizarrely reported that inflation had fallen, though it admitted that it was “stubbornly high.” This is, at best, a half-truth. It borders on an outright lie. The Consumer Price Index year-over-year was down to 8.3%, compared to the 8.5% it was in July and the 9.1% it was in June. That said… what difference does it make? The relevant figure that we want is the month-to-month figure. Experts were expecting inflation to decline by 0.1% and instead it increased by 0.1%. That’s the truth, no matter how the media wants to disguise it.
President Biden, not surprisingly, tried to put the best spin on it:
Today’s data show more progress in bringing global inflation down in the US economy. Overall, prices have been essentially flat in our country these last two months: that is welcome news for American families, with more work still to do. Gas prices are down an average of $1.30 a gallon since the beginning of the summer. This month, we saw some price increases slow from the month before at the grocery store. And real wages went up again for a second month in a row, giving hard-working families a little breathing room.
President Biden admitted that “it will take more time and resolve to bring inflation down,” and said the “Inflation Reduction Act” was part of that. There are some elements of the bill that may reduce costs, notably on health care. However, trillions in new spending is unlikely to stop inflation overall.
More importantly, the markets ignored the spin. The Dow suffered its worst drop since June 2020, losing an eye-watering 1,276.37 points, or 3.94%. The S&P 500 dropped 4.32%. The NASDAQ composite suffered a catastrophic loss of more than 5.1%.
The reason the market reacted so strongly is because the Fed has been continuously reminding us that it will keep raising interest rates until it meets its inflation target. Less than a week ago, Chairman Jerome Powell said: “History cautions strongly against prematurely loosening policy. I can assure you that my colleagues and I are strongly committed to this project and we will keep at it until the job is done.”
That was likely the last time we’ll hear from Chairman Powell until the Fed’s next meeting on September 20-21. Given yesterday’s news, a half-point interest rate hike, which would have sent the market surging, is almost out of the question. A three-quarters of a point hike looks more likely… and we can’t rule out something even greater.
Will any of this even make a difference? A paper released at the same Jackson Hole summit where Chairman Jerome Powell spoke a few weeks ago argued that fiscal spending is responsible for inflation. In other words, things like the “Inflation Reduction Act” are promoting inflation. And it’s hard to believe Chairman Powell doesn’t know this, or at least isn’t aware of the arguments.
The paper, authored by Francesco Bianchi and Leonardo Melosi of Johns Hopkins University and the Federal Reserve Bank of Chicago, practically scolds policymakers:
Trend inflation is fully controlled by the monetary authority only when public debt can be successfully stabilized by credible future fiscal plans. When the fiscal authority is not perceived as fully responsible for covering the existing fiscal imbalances, the private sector expects that inflation will rise to ensure sustainability of national debt. As a result, a large fiscal imbalance combined with a weakening fiscal credibility may lead trend inflation to drift away from the long-run target chosen by the monetary authority.
The conflict in Ukraine, which looks likely to intensify, is going to put more pressure on fuel costs and likely drive Europe into recession. China, because of its own unwise domestic policies, may avoid recession but will fail to meet its economic target of 5% growth this year. It will not even come close.
The danger now is that the Fed will push the American economy not into a soft landing but into an unnecessary recession. The Fed has previously admitted that many of the factors driving inflation are completely out of its control. These include the geopolitical situation, supply chain disruptions, new COVID-19 outbreaks (and resulting shutdowns in China), and labor troubles. That last factor may become especially relevant if we face a nationwide rail strike on Friday. The White House has said a shutdown is “not acceptable,” but this could obviously cause problems with the union turnout it will need in November.
The economy is on a knife’s edge, and yesterday’s inflation surprise is the last thing traders expected or needed. Look for the Fed to continue with an aggressive strategy – even if it doesn’t bring results in containing inflation. When all you have is a hammer everything looks like a nail. Unfortunately, that’s the position of our central bankers today.
Stay liquid, look for value stocks, and don’t sell in a panic.
Stay connected. It’s times like this fortunes are made.
Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com to bring you news on what those with power are debating, planning, and doing.