The Fed Hasn't Done Enough to Beat Price Inflation

By Mike Maharrey, Money Metals Exchange

Price inflation was supposed to be dead and buried months ago. But it’s doing just fine, thank you very much. The January Consumer Price Index report makes that pretty clear.

Sure, the Federal Reserve managed to knock inflation down. But it was never out. As a CNBC headline put it, “Inflation just won’t go away.”
The fact of the matter is the central bank never did enough to make it go away.

And it probably never will.

In December, headline CPI went up from 3.1 to 3.4 percent. The mainstream financial pundits assured us it was a blip on the radar -- transitory if you will. The January data makes it harder to believe that narrative.

After December’s surprise increase, annual CPI fell back to 3.1 percent in January, according to the latest BLS report. The fact that the annual number came down could be spun as good news, but considering the projection was for a steeper fall to 2.9 percent, it’s hard to crank up a celebration. And the decrease just brought annual price inflation down to its November level.

It’s fair to argue that one or two months of data don’t tell us a lot. So, what is the trend?

Hotter, not cooler.

If you annualize the CPI over the last three months, it comes to 4 percent, up from 3.3 percent.

The 6-month annualized CPI is 3.7 percent, up from 3.2 percent.

On a monthly basis, consumer prices rose 0.3 percent, equaling the December gain. That was a steeper increase than the projected 0.2 percent.

Now consider this: prices have gone up over half a percent (0.6 percent) in just two months.

Things look even better for the inflation monster when we consider core CPI. This is supposed to be a better metric because it strips out more volatile food and energy prices.

In January, core CPI rose 0.4 percent, and it was up 3.9 percent on an annual basis. The monthly number was up from 0.3 percent last month, and the annual number was unchanged. The projection was for a 0.3 percent month-on-month gain with the annual number falling to 3.7 percent.

As was the case with the headline number, the trend in core CPI looks good for team inflation. It has been hovering in the 4 percent range since July. That’s double the mythical 2 percent target.

To put the monthly core CPI increase in perspective, it would need to average just under 0.17 percent per month to hit the 2 percent annual target.

The Fed claims to be data-dependent. Well, the data tells us that any talk of inflation’s demise was premature. No matter how you slice, dice, or massage the numbers, nothing indicates the Fed is anywhere near winning this fight.

And keep in mind, inflation is worse than the government data suggest. The government revised the CPI formula in the 1990s so that it understates the actual rise in prices. Based on the formula used in the 1970s, CPI is closer to double the official numbers. So, if the BLS was using the off formula, we’re looking at CPI closer to 6 percent.

And using an honest formula, it would probably be worse than that.

“The much-anticipated CPI report is a disappointment for those who expected inflation to edge lower allowing the Fed to begin easing rates sooner rather than later,” LPL Financial chief global strategist Quincy Krosby told CNBC.

“Across the board numbers were hotter than expected making certain that the Fed will need more data before initiating a rate cutting cycle.”

The markets made that disappointment clear. After all, they’re desperate for a fix of their easy-money drug. With price inflation alive and well, the Fed will likely delay the party. So, the markets threw a tantrum.

The stock markets sold off Tuesday. The Dow was down over 524 points. The S&P 500 slipped back below 5,000, shedding nearly 1.4 percent. And the NASDAQ fell 1.8 percent.

Meanwhile, bond yields – i.e. interest rates – rose and the dollar reached its almost two-month high above 104.70.

Gold plummeted, testing the $2,000 per ounce support.

Of course, hope springs eternal. The stock market rallied on Wednesday, and the S&P 500 reclaimed 5,000. A USB Wealth Management analyst told Bloomberg, “The ‘hot’ inflation data do not change our base case for a soft landing.”

Despite the recent data, deep down, everybody still seems to believe the Fed has successfully beaten price inflation down.

Or maybe it's just wishful thinking. Regardless, the consensus still seems to be rate cuts are coming – if a few months later than hoped for. And to be fair, that's what the central bankers over at the Fed told us.

The Fed Never Did Enough to Win the Inflation FightYou have to admire the mainstream’s optimism, but the fact of the matter is inflation is alive and well because the Fed never did enough to kill it.

If the central bankers at the Fed were truly committed to driving price inflation back to 2 percent, they would be talking about additional rate hikes - not pending rate cuts.

Make no mistake; 5.5 percent interest rates are high for an economy loaded up with debt. But they aren’t high in the face of a 6 percent CPI (using the more honest 1970s formula).

Even using the current rigged CPI, the Fed’s inflation fight was relatively tepid.

Price inflation peaked at 9.1 percent in the summer of 2022. The Fed never pushed rates anywhere near that level.

Looking at how Federal Reserve Chairman Paul Volker handled the 1970s and 80s inflation is informative.

Volker went on the warpath in 1980 and raised rates to 20 percent. At the time, CPI was in the 14 percent range. CPI didn’t return to 2 percent until 1986. At that point, the average Fed funds rate was 14.35 percent. Even with that, the CPI spiked back up for several years in the late 80s and early 90s.

You’ll notice that Volker drove rates significantly above the CPI. But Powell is no Volker. You could argue that rates a modestly above CPI today, but if we were using the 1970s formula, real rates are still negative.

The Fed hasn't been any more aggressive on the other from in the inflation fight - balance sheet reduction.

To date, the Fed has rolled about $1.29 trillion off the balance sheet. This sounds impressive until you realize that the central bank blew up the balance sheet by $4.81 trillion in only two years in response to the pandemic.

Based on the central bank’s balance sheet reduction plan announced in March 2022, it would take 7.8 years for the Fed to shrink its balance sheet back to pre-pandemic levels. That doesn’t even begin to touch the trillions added to the balance sheet in the decade after the 2008 financial crisis.

The truth is, the Fed was never all in on the inflation fight. It couldn’t swing for the fences without wrecking the economy. So, it settled for a bunt.

Now, it is fair to say monetary policy is “tighter.” But it certainly isn’t tight.

In fact, the Chicago Fed’s own National Financial Conditions Index confirms this. The NFCI came in at –0.51 in the week ending February 9. That negative number means financial conditions are historically loose.

Nevertheless, almost everybody remains convinced that the Fed has got this. They remain confident that the Fed will give them back their easy money soon and that will float the economy to the much-anticipated soft landing.

The irony is that even if they’re right (and I don’t think they are) the victory over inflation is really just a surrender.

“Winning” means going right back to the inflationary policies that got us here to start with. In other words, the markets want inflation dead so they can have inflation back.

Keep in mind that in effect, loosening monetary policy is inflationary. Rising prices are a symptom of monetary inflation. And monetary inflation is exactly what we will get when the central bank reverts to a looser monetary policy.

As I explained on the latest Money Metals’ Midweek Memo podcast, the Fed is between a rock and a hard place.

On the one hand, it can choose to stick to its guns, keep rates higher for longer, and bring down inflation. But that will almost certainly drag the economy into a crisis.

On the other hand, it can pick inflation and maybe rescue the economy.

And the reality is we may get both the rock and the hard place – stagflation.