Eyes on the Fed
Post from First Trust Economics Blog
Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist
Nov. 1st 2021
Investors will be focused on the Federal Reserve this
week and our expectation is that it will finally announce an
overdue tapering of quantitative easing. In addition, we
expect Chairman Jerome Powell to make it clear in the press
conference that he expects tapering to be completed by mid-
Inflation is clearly a problem. The CPI is up 5.4% from
a year ago. When October data arrive the year-ago
comparison will likely be 5.7%, the largest increase since the
early 1990s. Some of this is “transitory,” but not all of it, not
by a long shot. Housing rents were held down artificially until
early September, due to limits on evictions. Once nationwide
eviction limits ended, rents escalated in September and we
expect more of the same for the foreseeable future. That’s
important because rents make up more than 30% of the CPI.
Given the likely pace of inflation in October, the “real”
federal funds rate (the funds rate adjusted by inflation) is
running at about -5.6%. That’s a record low, even more
deeply negative than the -5.0% in early 1975 and -4.8% in
mid-1980, both of which were at the end of recessions, not
almost a year and a half into a recovery, like we are right now.
In other words, the current economic environment
doesn’t just warrant tapering, but rate hikes. Unfortunately,
rate hikes aren’t happening anytime soon. We wouldn’t be
surprised by just one rate hike at the very end of 2022, but the
start of a hiking cycle could also be postponed until 2023.
First, the Fed is very unlikely to raise rates until after it’s
done tapering, so that alone delays hikes until at least mid-
2022. Second, we think the Fed will be reluctant to start
hiking a few months before the mid-term elections.
And third, personnel changes at the Fed will likely give
the Fed a more dovish tilt in 2022. There’s already a vacancy
on the Fed Board, two openings to fill for bank presidents in
Dallas and Boston, and we think Trump-appointees Richard
Clarida and Randy Quarles will be gone by mid-2022, due to
the expiration of their terms as Vice Chairman and Vice Chair
for Supervision, respectively.
The problem with monetary policy is that the M2
measure of money is up 36% since February 2020, versus a
trend of about 6% annualized pre-COVID. That surge in M2
is like a cow that’s been eaten by a snake…gradually moving
through. As long as the Fed doesn’t regurgitate the extra
money, the cow isn’t going away, which, in this case, means
a devaluation of money relative to goods and services.
That doesn’t mean higher inflation forever, but it does
mean a prolonged period of higher inflation until the extra M2
is fully digested by the economy.