What a swell party this is… never seen such gaiety,” warble the dynamic duo of Crosby and Sinatra in Cole Porter’s “High Society”. Wake up on Monday morning, overpay for a new house, have a capital gain by the weekend. Buy a new car at a premium price, and next week sell it used for more than you paid for it new. Buy shares in a company you never heard of that promises to produce a product you don’t understand, and by next week you’re up there with Warren Buffett as an investor-genius. Don’t like your boss’s attitude, tell him to take his job and stuff it, and with twice as many job openings (11.5 million) as there are job seekers, start a new one at a 40 percent raise, no inconvenient travel to an interview necessary.
Sure, the family member who returns from the supermarket is upset at the high prices, but the frown will turn to a smile when the deceptively thicker pay packet arrives at the end of the month. Meanwhile, take another whirl around the floor with Rosie Scenario. Never mind that ominous-looking black swan that just dropped in from Russia.
Fun, fun, fun until the chairman takes the punchbowl away, as the Beach Boys might have put it. Which Jay Powell did last week or, as his critics believe, timorously issued a warning that he would be refusing to refill it until the revelers sobered up.
The Fed Discovers High Inflation
“Inflation is much too high,” announced Fed chairman Jay Powell, a reasonable conclusion from the fact that it is running five full percentage points higher than the Fed’s median forecast at the end of 2020. But not so high as to persuade the Fed to raise its benchmark rate from negative territory (inflation adjusted), in which it remains even though last week’s one-half percentage point rate increase was the largest hike since 2000. Or to convince it to shrink its balance sheet as rapidly as previously mooted. Of course, the size of future doses of anti-inflation medicines are subject to continuing review at future meetings of the Bank’s monetary policy committee.
Powell believes the economy is strong, which it is. The economy added 428,000 in April and the unemployment rate is a low 3.6 percent, “tight to an unhealthy level” says Powell. Economists surveyed by The Wall Street Journal expect growth in the final quarter of the year to top 2021 by 2.6 percent. Consumer sentiment hit a three-year high in April and consumer spending is a bit higher than it was when last year ended. Business spending is almost 10 per cent higher. While the Fed chairman was delivering his remarks more Americans than before the pandemic were again visiting their gyms en route to their favorite eatery, and traveling to concerts, spas and business meetings.
When Good News Is Bad News
Here’s the oddity: good news is bad news for those who believe the economy must be cooled if the inflation genie is to be re-bottled. Optimists are predicting a mild recession, pessimists a major recession, and self-styled über realists such as Larry Summers, stagflation – continued high inflation combined with a sinking economy. The Lindsey Group notes that all seven of the disinflationary efforts of the Fed since 1951 have been associated with recession.
Many experts believe the Fed will eventually be forced to raise its benchmark interest rate to levels far above anything it is now contemplating. Former Fed vice chairman Richard Clarida says that if inflation is running at a 3 percent rate at this time next year the Fed will have to raise rates to 4 percent to get inflation down to its 2 percent goal. Most economists with whom I talk view that as a conservative guess.
Higher rates deter some consumers from buying houses, cars and appliances, and curtail business investment – destroying demand in the jargon of the trade. In the process, cooling job creation and lessening upward pressure on wages.
Housing Market Softens But Maybe Not A Lot
Consider only what higher interest rates already mean for the housing market. Fearing they will be repaid in depreciated dollars, lenders have doubled rates on popular 30-year mortgages, increasing them by 2.5 full percentage points last year at this time to above 5.6 percent, headed for 6 percent or higher. Combined with a 34 percent jump in house prices since the start of the pandemic, that will raise the monthly carrying cost of the average home by $1,900 with a 20 percent down payment, and over $2,000 per month for buyers who can only scrape up a 10 percent down payment.
Brad Stiehl, a prominent Arizona real estate agent, tells me that sellers who reveled in bidding wars and instant closings only a few weeks ago now find themselves hoping that a prospective buyer does not back out of a deal after finding out what his or her or their monthly carrying charges will come to. Nationally, home buyer sentiment is at a record low.
Still, there is a pent-up demand for housing that has many experts believing that higher interest rates will not have as great a deadening effect on demand as they have had in the past. Such differences among experts are one reason to have some sympathy for Fed forecasters who are trying to figure out the likely macroeconomic effect of the tightening they contemplate.
If the Fed is right that softly, softly will bring inflation under control, it is piloting the economy towards a soft landing. If its critics are right, that Fed policy is adding too little to too late, fasten your seat belts for a bumpy future. With exquisite timing, Powell took a relatively large three-quarter point increase in the benchmark rate at the June meeting off the table — two days before the buoyant jobs report suggested that is what the economy needs.
Uncooperative Xi, Putin, Ports And Chips
Powell has one thing right: the Fed can’t control the supply side of the economy.
- Xi Jinping has closed down an economy that manufactures just about everything every company needs to keep its factories operating, and is driving up prices of fertilizer and steel by curtailing exports.
- Vladimir Putin has launched a war that is driving up the prices of commodities from wheat to sunflower oil to uranium to fuel oil to natural gas.
- Supply-chain bottlenecks have tightened, reports the Global Supply Chain Tracker, and will tighten further when Xi re-opens China’s factories and ports, from which a huge backlog will head for the U.S. West Coast ports.
- A shortage of chips needed to make the machines that make chips needed to end the shortage of chips is now expected to last two or three years.
- Oil supplies will remain constrained by OPEC and by the administration’s restriction on permitting for leasing and pipeline construction.
Joe To Join H.W. And The Donald?
Voters say inflation is their number one concern, and know wage increases are lagging prices. If the Fed can’t bring inflation down significantly by the time voters troop to the polls (54 percent) and mailboxes to send in their ballots (46 percent) for the November congressional elections, Joe Biden will join George H.W. Bush and Donald Trump as presidents regretting their choices of Fed chairmen.