Will the Fed Stay in the Ring With Inflation? Or Is the Tough Talk Just Hot Air?

Cooling Consumer Price Index data did not cool the hot rhetoric coming from some Federal Reserve members. The question is whether this is a bunch of hot air or do these central bankers actually have the fortitude to move forward with rate hikes in the face of a sinking economy?

The stock market rallied on news that the CPI came in at 0% month-on-month. The year-on-year CPI remains extremely elevated at 8.5%, but that was lower than expected. And while core CPI did rise 0.3% month-on-month, even that was slightly below expectations. This led most market analysts to believe that the Fed would probably slow its roll on interest rate hikes, and some were even speculating the Fed will start cutting rates early next year.

Rate hikes have drug the stock market down, along with the overall economy. GDP has contracted for two straight quarters, meaning that outside of the Orwellian spin world created by the White House, the US economy is already in a recession. The housing bubble has popped and the air is coming out faster every day. Real incomes continue to drop. Productivity tanked. Americans are making ends meet with credit cards. Peter Schiff argues that the recession is here and it’s only going to get worse.

We’re going to get a third negative quarter. We’re going to get a fourth negative quarter. We’re going to be seeing contracting GDP for years. This recession is just getting started.”

The Fed playbook in this scenario is rate cuts. But rising prices back the Fed into a corner. The central bank can either keep raising rates and shrinking its balance sheet, risking a complete economic crash, or it can follow the playbook and go back to loose monetary policy in order to stimulate the economy.

So far, the pundit class at both the Fed and the Biden administration have been able to spin their way out of worrying about the economy by pointing at the “strong” labor market. But in truth, it’s not that strong.

Most people, myself included, thought the Fed would use the cooling CPI data as an excuse to pivot. But two Fed members poured cold water on that idea.

Minneapolis Federal Reserve Bank President Neel Kashkari said the Fed remains “far, far away from declaring victory” on inflation. He went on to say he hasn’t seen anything that changes the trajectory of the Fed’s inflation fight. Kaskari remained adamant that the central bank needs raise rates to 3.9% by the end of the year and to 4.4% by the end of 2023. He even insisted he won’t be deterred by a recession.

Chicago Fed President Charles Evans also said the Fed still needs to get rates to 4% by the end of 2023. But Evens left a lot more wiggle room than Kashkari, saying, “If things get better more quickly, we can not raise rates quite as much as I’ve just indicated … I think we’re well-positioned now for a couple of different turns of the data over the next few months.”

Is This Real Talk?

Jerome Powell and other members of the Federal Reserve have talked tough for months. But is this real talk? Or is it just posturing to maintain their credibility? To ask the question another way, will they stay in the fight when the punches start flying?

Despite the jawboning, the Fed’s actions have been pretty meek. After insisting inflation was “transitory” for months, the Fed has only raised rates to 2.5% despite CPI hitting 9.1% in June. Powell and Company are still way behind the inflation curve. Real rates remain deeply negative and will continue to do so even if they hit Kashkari’s end-of-the-year goal. Meanwhile, the Fed hasn’t even managed to meet its modest balance sheet reduction goals over the first two months of quantitative tightening.

This indicates to me that the Fed isn’t as serious about fighting inflation as they want you to believe. If they really believed inflation was a serious problem, they would have been much more aggressive much faster.

Why was the Fed so slow to respond, and why so tepid in its response?

There is an ugly reality looming ahead, and Powell, Kashkari, Evans and the whole lot of them have to know this. They can’t keep raising rates without a major economic crash.

The Fed and the US government built this economy on printed money, stimulus checks and debt. It looks like taking away the easy money punch bowl has already popped the bubble. We haven’t even felt the impacts of the July rate hike. It will only make the rip in the bubble bigger, letting the air out even faster. It’s only a matter of time before the entire house of cards economy collapses.

In fact, they’re almost certainly already beyond the point of no return.

After every round of easy money since the 80s, the peak interest rate during the recovery has fallen. In other words, the tipping point for the economy has come at a lower and lower maximum interest rate.

The Fed has already driven rates beyond where history would indicate the economy will get shaky. And as I’ve already shown, the economy is in fact shaky.

The Fed managed to drive rates to 2.5% more than a decade after the Great Recession. It didn’t end well. The economy got shaky, the stock market crashed, and the Fed quickly ended the tightening cycle. In fact, it went right back to loose monetary policy. (Not that 2.5% interest rates are particularly tight.) As you’ll recall, in 2019, the Fed cut rates three times and had already gone back to QE – even before the pandemic.

So, what makes anybody think the Fed can push rates to 3 or 3.5% today with even more debt in the economy?

It can’t.

So, the question is — will the Fed soldier on in the inflation fight despite a deep recession?

And it will be a deep recession. This notion we’re about to have a little short downturn is in the same wishful thinking category as transitory inflation.

Schiff thinks the tough talk from the Fed is nothing but hot air.

At some point, the economy is going to be so weak that FOMC members are not going to be able to pretend that it’s strong. They’re not going to be able to shrug off all the evidence of a severe recession. And we are going to get the pivot.”

Schiff went on to say the Fed will keep up the pretense and bluff as long as they can. But ultimately, they’ll show their cards and make that pivot back to loose money.

If they don’t there is no guarantee the recession won’t spiral into a deep depression. And that still might not slay the inflation dragon.

For now, the Fed members aren’t showing any cracks in their resolve. But with the Fed, things shift with the wind. You’ll recall that a few months ago a 75 basis point rate hike “wasn’t on the table.” A week later, the Fed delivered a 75 basis point hike.

So, it would be wise not to put too much stock in what Fed people say today. The tune may well change tomorrow.