Friday’s jobs report for December widely missed its mark, printing at just 199,000 jobs when 400,000 were anticipated. The dismal report raised doubts about the likelihood the Fed would hold to what seemed like an assured interest rate increase just two days earlier, when the Federal Reserve released its minutes from its December meeting.
The Fed minutes hammered the tech-heavy NASDAQ, moving the index down 686.82 points, or more than 4 percent, by Friday’s close. Moreover, news that the Fed was likely to raise rates cratered Bitcoin by 8 percent from Jan. 4’s close to the weekend. Now, the disappointing jobs report has left analysts in a quandary.
Make no mistake: Milton Friedman was right when he said, “Inflation is always and everywhere a monetary phenomenon.” As I wrote some weeks ago, there is simply too much money—as measured by M2—in the economy pushing too few goods in the economy, particularly hydrocarbons, other energy, and vehicles. Moreover, U.S. productivity in the third quarter of 2021 declined by a staggering 5.2 percent—the largest decline in over 60 years. Consequently, all that cash is chasing even fewer goods.
In my view, the table has been set for continuing inflation, but a change in the discount rate—the interest rate that the Fed charges member banks—and other traditional Fed actions that affect short term rates, will act principally on the securities markets, not inflation. Banks already have record high deposits; nearly $18 trillion, which is close to the entire U.S. GDP. The banks are flush with cash. There is no need for banks to borrow from the Fed, so boosting the discount rate will do little. If there is no reduction in the size of the Fed balance sheet, and M2 inflation will likely continue above the Fed’s 2 percent target.
It’s telling that Fed Open Market Committee (FOMC) participants projected a maximum 3.2 percent Personal Consumption Expenditure (PCE) inflation rate, and that was from a single participant. This is a different measure of inflation than the more widely reported Consumer Price Index, and the one the Fed prefers. But it is still indicative of where FOMC members think inflation is headed.
On Wednesday, the Bureau of Labor Statistics (BLS) will release the December Consumer Price Index, or CPI, which should provide greater guidance to the Fed as to whether they will raise rates.
Like most analysts, I anticipate Wednesday’s report to show a slowdown in inflation, but still above the Fed’s 2 percent inflation target. The FOMC will meet at the end of this month, and there will be additional data on inflation, but I don’t believe the Fed will move to increase rates at that meeting unless Wednesday’s inflation number for December markedly exceeds expectations.
If the Fed raises rates at all in the first quarter, we believe it will be at the March 15–16 meeting, where it will have publicly available economic projections to support any change in Fed policy.
But I’m not inclined to think there will be a first quarter rate hike because, like the majority of the FOMC participants, I’m pretty sure the 6.8 percent November CPI inflation number was an outlier and that prices will stabilize. Inflation will continue, but at a lower rate of increase.
The Fed, for all its protestations to the contrary, is accountable to a political leadership and it is unlikely—although still possible—it will rattle markets with even a quarter point interest rate in an election year. Instead, we think the Fed at its January meeting will do as I encouraged last month: signal that it is ceasing its purchases of Treasury and mortgage securities; then, at its March meeting, the Fed will signal it will start selling them off.
These sales will have the effect of raising longer term rates, which will, in turn, give the Fed some leeway to address shorter term rates should inflation continue markedly above 2 or 3 percent for the balance of the year.
An asset sell off works as a Fed “insurance policy” that allows it to have cake and eat it, too: it can cool inflation now without unsettling the markets and it also creates a free option to raise short term rates without narrowing—or inverting—the yield curve.
That’s the Fed’s best and safest play.