US Fed will think twice before pausing rate hikes, another two times before pressing the pivot button

Inflation came back to haunt Paul Volcker who resisted repeated calls from the Congress to lower rates.

US Fed, Pivot, rate hike, inflation, money supply, economy
One could partially attribute the sudden resurgence of inflation to a differently charactered animal in the U.S., the M2 money supply.

Just like COVID-19 and most other pandemics (Spanish Flu etc.) had multiple waves, similarly inflation too might have similar peaks. It is up to the central bank to ensure pre-emptively that these peaks do not recur and if they do, the magnitude or volatility should not shock the economy.

In this context, the Fed in the early 1980s had attempted to provide some relief to an economy stricken with unemployment by lowering rates. But inflation came back to haunt then Chairman, Paul Volcker who had to salvage the credibility of the Fed by maintaining an iron hand and resisting repeated calls from the Congress to lower rates.

This time around, the Fed is mindful of various inflation dynamics and would think twice before pressing the Pause button and probably another two times before pressing the Pivot button.

Consensus trade towards the end of CY22, almost round the world was that the worst is behind us, and the Fed should likely tone down and meander to at least a pause if not pivot. However, inflation in the U.S. has once again proved how difficult a monster it is to tame.

With the benefit of hindsight, one could partially attribute the sudden resurgence of inflation to a (currently) differently charactered animal in the U.S. M2 money supply. Earlier during similar easing environments like the QEs, M2 did not particularly inflate notoriously.

However, this time around (post COVID-19) the concoction of heady economic easing combining the Fed’s erstwhile lower for longer stance, various other monetary and fiscal tools and possibly, even the wealth effect as well, stemming from inflated asset prices bloated M2 to ugly levels which has fed fodder to the inflation demon.

On top of this, if one deviates away from the Fed’s focus on PCE (which has a more pharma/medical heavy basket) and glances at the U.S. CPI itself (which is more real estate/shelter focused) then because of the even longer rebalancing period in the latter (rebalancing into a cheaper good), one could have a higher for longer inflationary trend persisting in the CPI. These point to the current inflationary spike in the U.S. probably not being so much of a backward statistical low base effect.

(Source: LGT Wealth India – Monthly investment perspectives for March 2023)

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First published on: 11-03-2023 at 18:05 IST
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