What the Federal Reserve is Really Afraid Of…

Maybe he did and maybe he didn’t. 

Did Jerome Powell let a big secret slip at last week’s FOMC press conference?

Whoever is at the podium while delivering an FOMC statement has the sworn duty and obligation to obfuscate the message as much as possible while trying to proclaim complete transparency. 

Personally I think he did the best he could. But if you listened closely to what he was really saying in his Q&A, you understood the real problem the Fed is facing…

Saying the Quiet Part Out Loud

That real problem was summed up in this Q&A exchange (my emphasis):

Q: Are you targeting headline inflation now or core inflation? In other words, how far would you chase oil prices if they keep going up? If that’s going to be the component that drives expectations, would you risk recession for a headline rate if the core rate is holding steady or starting to go down?

JP: …we’re responsible for inflation in the law. And inflation means headline inflation. So that’s our ultimate goal. We of course, like all Central Banks do, look very, very carefully at core inflation because it is, it’s a much better predictor and it’s much, it’s a much better predictor of where inflation is going and it’s also more relevant to our tools. As I mentioned, the parts that don’t go into core are mostly outside the scope of our tools, so we look at that. … So we can’t really have much of an effect, but we have to be mindful of the potential effect on inflation expectations from headlines. So it’s a very difficult situation to be in and we, again, we can’t do much about the difference between the elements that make up headline that are not in core.

Let’s break that down into a little more understandable language…

The questioner was asking Powell about two different measurements of inflation. “Core” inflation numbers exclude food and energy prices. That might sound ridiculous, but the idea behind it is that those elements are too volatile and can skew projections of where inflation is really going.

The problem is both food and energy prices are included in what’s known as “headline” inflation — aka CPI or the inflation that everyone knows from the gas pump and the grocery store. 

The reporter was asking whether the Fed would keep hiking interest rates (and risk slowing the economy into a recession) if energy prices kept headline inflation rising while core inflation (the prices of everything else) started coming back under control.

Powell deftly avoided answering the question by saying “the parts that don’t go into core are mostly outside the scope of our tools.”  Basically that means there’s nothing they can do about food and energy prices. 

So Why Would They “Chase” Energy? 

Because headline inflation creates a perception in the public mind of where inflation is headed. And the Fed is heavily invested in making the public believe that they can hold inflation to their 2% goal.

In Fed-speak, that’s called “anchoring expectations.” As long as consumers and investors believe that inflation will be around 2%, they’ll live and invest like inflation is 2%. 

But if expectations become un-anchored — when people start believing that 4% or 5% or 6% inflation will be the norm — that’s when problems arise. People alter their spending habits. Investors alter their investing habits. And maybe most importantly, the Fed starts to lose its credibility.

Essentially what the reporter was asking about is a worst case scenario for the Fed. 

It’s not that the Fed doesn’t care about non-core elements, there’s just little they can really do to affect them.  What they do care about are the expectations that those elements create. 

If they can’t keep inflation down, they’re going to do everything they can to keep expectations anchored down…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Daily