This is the conclusion of today’s Morning Brief, which you can read Log in Delivered to your inbox every morning, along with:
Hotter-than-expected inflation pressures rattled bond markets on Wednesday, sending the 10-year U.S. Treasury yield (^TNX) rising to 4.56%, its highest level since November. The jump (18 basis points) was the largest in almost two years.
The resulting volatility impacted stocks – particularly the interest rate-sensitive sectors of real estate, utilities and regional banks – and gave the Russell 2000 (^RUT) its worst trading day in eight weeks, down 2.5%.
Since December, the Fed has all but promised that rate cuts are likely in 2024, based on the assumption that price increases have moderated and are moving toward the Fed’s 2% inflation target.
A closer look at the inflation numbers shows that many components are clearly trending upward, including the Fed’s touted “supercore” services number, which excludes housing prices.
As Torsten Sløk, chief economist at Apollo Global Management, told his clients, the year-on-year change in supercore inflation is currently at 5%, while the three-month change has risen to 8% – not far from its peak in early 2022, which was then a 40 year high. (Disclosure: Yahoo Finance is owned by Apollo Global Management.)
The Fed’s goal is to avoid a repeat of the double inflation episode that rocked the 1970s and early 1980s. To this end, in 2022, James Bullard (as President of the St. Louis Fed) wrote an important letter about this past period of inflation.
After price inflation rose to 12% in 1974, the Arthur Burns-led Fed quickly kept interest rates relatively low, even as inflation rose again.
“What followed was high and fluctuating inflation over the next decade,” as inflation remained stubbornly above 5%. “[T]“The real economy has been volatile, in part because high inflation distorts price signals, which can affect real economic activity.”
In 1979, after price inflation rose to over 10% againPaul Volcker was installed as Fed chairman to finally put the genie of inflation back in the bottle.
But even Volcker made a mistake in his early days as Fed chairman. Less than a year into his eight-year term, the federal funds rate was above 20% while the CPI peaked at 15%. The Volcker Fed quickly cut the key interest rate to 9% within a few months, only to reduce it to 20% in 1980.
From then on, the Fed cut the key interest rate to 16%, but the central bank was again forced to raise its key interest rate to 20% – the third time in just over a year.
By 1983, inflation had finally fallen to a bearable 2.5%. This time the Volcker Fed was prepared as it trended higher.
“The year 1983 [Federal Open Market Committee] “Focused more on monetary factors affecting inflation and consequently kept the key interest rate relatively high even as inflation declined,” Bullard said.
And while the Fed kept its key interest rate high relative to inflation, the US economy continued to hum.
“One might have expected that high real interest rates would trigger a recession, but that hasn’t happened,” Bullard said.
Higher for longer? History rhymes.
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