The Consumer Price Index (CPI) numbers came in for May 2022 hotter than expected. The year-over-year rate now stands at 8.6%. The expectations (by the “experts”?) estimated a number of 8.3%.
For the month of May alone, the price level jumped 1.0%. If you annualize this number, we are at 12% annual price inflation. In other words, price inflation is getting worse, and it was already bad.
The more stable median CPI rose 0.6% for the month of May, and it now stands at a year-over-year rate of 5.5%.
Stocks took a dive on the news, probably in anticipation of more aggressive tightening from the Fed. Yields across the board also rose. Interestingly, the price of gold finished higher for the day, indicating an increased fear that the higher price inflation might be here for a little while.
It is now expected that the Fed will raise its target rate by at least 0.5% (50 basis points) in its upcoming meeting, but it may go even farther with a 75 basis point hike.
After the announced CPI numbers, I heard Jim Cramer on CNBC saying that Jerome Powell and the Fed should just do an immediate hike of 1%, or 100 basis points. He said Powell is too incrementalist and doesn’t want to shock the market.
I don’t have much respect for Cramer, especially these days, but it is interesting that he is advocating this. He is known for being a stock bull. If he thinks a 1% immediate hike in the federal funds rate is appropriate, it means that the powers-that-be are concerned about what is happening.
Of course, rates are just one piece of the story. It is ridiculous that the yield on a 3-month Treasury is still less than 1.5% while price inflation is nearing double digits annually. Real interest rates are deep into negative territory. The Fed would have to hike a lot more than 1% to cure this problem any time soon.
Another piece of the story that gets far less attention is the Fed’s balance sheet. This essentially represents the base money supply. It may have just peaked for this cycle. The Fed just recently started to very slowly decrease the balance sheet. Why it didn’t do this last year is a big question that doesn’t get asked a lot.
There is no question that Jerome (Jay) Powell got it completely wrong by saying that inflation was transitory. Janet Yellen (former Fed chair and current Treasury secretary) also got it completely wrong and recently admitted so. These are our “experts” who think they are in charge of the economy.
The FOMC will release its next monetary policy statement next week. I think it will have a hike in the federal funds rate of at least 50 basis points (0.5%). Maybe it will be 75 basis points. But the more the Fed tries to solve the inflation problem, the bigger risk it is for the Everything Bubble.
The massive bubbles we see in stocks, cryptos, real estate, etc. are built on loose money and low interest rates. When that is pulled away, it won’t hold up for long. We have already started to see the air come out of some of these bubbles in 2022.
The Fed Can Stop the High Price Inflation
Some people will contend that the Fed has lost control and won’t be able to tame price inflation. I contend that it is a question of will.
Every money relies on the faith of its users to some extent, even when it is a money imposed by the government. The people using the money have to have faith that others will accept it.
As long as we don’t have runaway inflation, I don’ think people are going to stop using U.S. dollars any time soon. With that said, the Fed can stop the price inflation if it chooses to do so. But the Fed officials have to be willing to risk a major economic downturn.
As Ben Bernanke once said in a speech, the Fed has a printing press or its digital equivalent. As long as the Fed is willing to create a lot of new money or credibly threaten to do so, it can create higher price inflation. And he has been proven correct on this one point, especially over the last year.
But I would say that the inverse holds too. As long as the Fed stops creating new money and credibly says that it will stop, at least for a while, then it can essentially kill the price inflation. We may get a hard recession, but it can stop the price inflation as long as they don’t get to a point of runaway inflation.
The only problem is that the Fed isn’t that credible these days. I think some people, and maybe rightly so, believe the Fed will just return to printing money (digitally speaking) at the sight of any major downturn.
My bet on this is that the Fed will bring price inflation down. And with it, they will bring down the Everything Bubble. They may return to inflationary policies after that. But in the short run, I expect the yield curve to flatten and for a major economic downturn, which will include declining asset prices.