Beckner: Market-Rattling CPI Neither Deters Nor Escalates Fed Rate Hikes

14 February, 2018

By Steven K. Beckner

The bigger than expected January jump in consumer prices is rattling Wall Street, but won't likely alter the Federal Reserve's basic monetary firming plans. Notwithstanding recent market turmoil, it's "all systems go" for "gradual" Fed interest rate "normalization," including the financial system. The inflation data reinforce but probably don't escalate that strategy. After a week in which the major stock gauges lost more than 5% before retracing some of those losses, Fed officials gave no indication they will refrain from further federal funds rate hikes. And the markets themselves seemed to be accepting that reality before the CPI. Don't make too much of Jerome Powell's brief comments at his swearing-in, but they did suggest calm confidence in the course the Fed has been on. While saying "we will remain alert to any developing risks to financial stability," Powell said "the financial system is incomparably stronger and safer" and "the global economy is recovering strongly..." So, "we are in the process of gradually normalizing both interest rate policy and our balance sheet with a view to extending the recovery and sustaining the pursuit of our objectives." Cleveland Federal Reserve Bank President Loretta Mester acknowledged the stock market had been on "a roller coaster ride" and that "longer-term bond rates have also moved up." After projecting faster GDP growth, below 4% unemployment and inflation rising to 2%, she said "if economic conditions evolve as expected, we'll need to make some further increases in interest rates this year and next year, at a pace similar to last year's." She said there is an "upside risk" that the Fed will have to do more. Officials' views are unlikely to be greatly impacted by the fact the CPI rose more than expected -- 0.5% overall and 0.3% core. The year-over-year CPI rate was unchanged at 2.1%, and the core rate ticked up just a tenth to 1.8%. Although more volatility undoubtedly lies ahead, Wall Street seems in the process of weathering its mini-taper tantrum and coming to grips with normalization. One must "take the rough with the smooth," as the saying goes: If you want faster growth, low unemployment, better wages and on-target inflation, you must accept somewhat higher rates. Besides, as Kansas City Fed President Esther Georoge notes, monetary policy remains "quite accommodative." The same could be said of financial conditions. The Fed has raised the funds rate just five times by 125 basis points after seven years near zero. Long-term market rates have belatedly adjusted higher, but not tremendously. Not long ago many feared the yield curve would invert and herald recession. Now, people see long rates soaring in anticipation of inflationary "overheating." Yet the 10-year note yield remains relatively modest, having risen 40 basis points this year to 2.85%. Rates are just getting back to some semblance of normal, if that; the funds rate is only about half way to the Fed's downwardly revised neutral estimate. As Mester, who is reportedly being considered to succeed Stanley Fischer as Fed Vice Chairman, observed, "Even with the recent movements, as of Friday, the S&P 500 index is still significantly higher than it was a year ago." And bond yields "are at levels seen at the start of 2014." This too shall pass.