Inflation’s Fight Seems Under Control, the Markets Have the Upper Hand

Chief Economist Eugenio J. Alemán discusses current economic conditions.

November’s inflation numbers delivered good news for the Federal Reserve (Fed) even though the Consumer Price Index (CPI) was higher than what markets were expecting, with shelter costs surprising to the upside. Meanwhile, the preliminary inflation expectations numbers from the University of Michigan’s Survey of Consumers showed that short, as well as long-term inflationary expectations, came down considerably in December, which will continue to support the Fed’s disinflation campaign.

But the real fight is the Fed fighting market expectations for lower rates as soon as March of 2024. That fight is still in its infancy from what we read in the Summary of Economic Projections, the dot plot, and heard during the press conference by Fed Chair Jerome Powell after the last meeting of the Federal Open Market Committee (FOMC). Markets have started to get ahead of the Fed and have brought down long-term interest rates, with the yield on the 10-year Treasury moving under 4.00% immediately after the December 13, 2023, decision.

Absent from the Fed governor’s discourse during this past press conference was the “higher for longer” or “high for longer” mantra the Fed has been using for the last year or so. That is, the Fed went from being very hawkish to being very dovish in less than a month and, perhaps, has made its forward guidance more difficult as markets have jumped ahead on this dovishness.

The new Fed mantra: Recognizing monetary policy’s ineffectiveness

We understand where Fed officials are coming from because the latest inflation numbers plus inflationary expectations have been highly supportive of the disinflationary environment. Furthermore, the Fed Chairman argued that much of the progress has been achieved not through monetary policy but through a normalization of supply chains as well as the normalization of the U.S. labor market, which has included a normalization of immigration.

They seem to be arguing/confirming that monetary policy was not the reason for the increase in inflation during the last several years so there is no reason to continue with the pretense that interest rates need to remain high for longer.