Last Thursday we had an inflation report, not just any report, but a wonderful report. Inflation came in at 7.7% over the year and 0.4% over the month, and core inflation came in at 6.3% over the year and 0.3% over the month. These numbers were well below expectations of 8% and 6.5%, respectively, which is of course why markets rallied over 5%.
Did Jerome Powell lie to us though at the last FOMC press conference? His entire tone at that meeting seemed to suggest that interest rates would need to be higher to combat this inflation that we are experiencing.
“Even so, we still have some ways to go, and incoming data since our last meeting suggest that the ultimate level of interest rates will be higher than previously expected”
The markets took this information and ran with it, selling off like mad to price in future rate hikes.
“Inflation remains well above our longer-run goal of 2 percent. Over the 12 months ending in September, total PCE prices rose 6.2 percent; excluding the volatile food and energy categories, core PCE prices rose 5.1 percent. And the recent inflation data have again come in higher than expected. Price pressures remain evident across a broad range of goods and services.”
These tones seemed to have suggested that the Fed would have to get tougher on stronger-than-expected inflation by raising interest rates higher.
Jerome Powell had to of had an idea that October’s inflation would come in well below market expectations, yet he chose to say “And the recent inflation data have again come in higher than expected”. Now I don’t know if he meant the hotter-than-expected inflation of September or August, but the fact of the matter is that inflation is now cooler than expected.
“Our decisions will depend on the totality of incoming data and their implications for the outlook for economic activity and inflation. And we will continue to make our decisions meeting by meeting and communicate our thinking as clearly as possible.”
So why then even with this information would Jerome Powell hold the stance of aggressive monetary policy? Why would he lie about the reality of the world we are living in?
What you have to understand is Jerome Powell is a part of a political organization that of course is meant to have no party affiliation. That political organization is highly bureaucratic and they have to adhere to strict policies. It also means that have to uphold an image.
Up until the meeting in early November the market had been pricing in a less aggressive Federal Reserve.
And here’s where things get juicy.
Jerome Powell is no dummy, he knows how markets work. He knew that markets had been pricing in a pivot, like everyone else, and knew that if he came out and gave dovish signals the market would price in a harder pivot and ultimately harm the Fed’s overarching goal of where they want interest rates to be. To add fuel to those flames he knew that inflation would come in below market expectation and the market would view that as “the Fed doesn’t have to go as high as they’ve said”. It is unreasonable to suspect that Jerome Powell doesn’t get this information way before anyone else.
They are in a balancing act between playing the markets and still achieving their terminal goal. Jerome Powell finessed the markets. He gave a hawkish speech to spook them into thinking they needed to go higher just before news arose that they maybe don’t. He let markets overestimate the terminal rate and then let them calm back down to the terminal rate the Fed wants all along.
They believe they need to get rates to a certain level to cool inflation. Of course, the level they choose is almost always too high.
What I want to know is what is the real current inflation rate, because I believe it is lower than the number we are told.
The problem with the Fed’s data is it is old. And the worst of it is shelter, which makes up ~32% of the CPI. The Federal Reserve uses what is known as owners equivalent rent. Essentially owner equivalent rent is the Federal Reserve sending a letter to your house and asking you what you would charge yourself if you were to charge rent to yourself. It’s somewhat bogus.
As you can see the real observed rent is drastically different than the OER the Fed uses to make policy decisions.
This is a clear problem because when you have a Fed that uses old data to make really drastic moves in tightening financial conditions you can just make things worse. That’s just a brutal reality.
But they are a bureaucratic organization that has to adhere to strict rules, this is one of them.
So the Fed may already have over-tightened. We may already have seen inflation a lot lower than we realize in the CPI print.
Now, this isn’t crazily lower that I am talking about, because the other components still show strength, but the fact of the matter is a major part of inflation is misinterpreted by the Fed and that could cause them to go too far.
By how much is unknown, but with the path they’ve been on it is likely they will go too far versus not far enough.
The point of this post is to highlight 2 things that you should be aware of:
The reason it cares is because it is looking for the two scenarios. Either we achieve a soft landing and the Fed pivots or we have a hard landing and the Fed pivots. Either way, the markets are looking for a pivot.
Once that happens this can all be over. Don't panic sell now, don't be part of the capitulation, be part of the smart money that follows capitulation.
If my follower base is as I intend it to be, we should all be making money. Now is a perfect time to be managing a budget and looking to buy assets.1
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