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Why I think this is the most reckless Fed ever and what the Fed should do to reverse and mitigate the effects of its policy errors

The credibility of the Federal Reserve has moved from an inflation fighter under Volcker to the creator of wealth inequality and an inflation arsonist under Powell. And everyone knows it.

By Wolf Richter of WOLF STREET.

This sounds surprisingly strange, but it’s a reality. Inflation has skyrocketed and worsened for over a year, and the Fed denied it by saying that the economy was recovering, and then denied it by saying: Well, it’s just a “basic effect”. And when inflation blew off after the basic effects were over, the Fed said it was a “temporary” blip due to some supply chain disruptions. He admitted that there was actually an inflation problem as it spread to services and rents that didn’t have a supply chain across China – the infamous pivot.

It was too late by that time. From the beginning of 2021, the “idea of ​​inflation” I called was firmly established.

I’ve been screaming about it for over a year. By January 2021, he screamed that inflation was widespread in the economy. By February 2021, I screamed that inflation was spreading to the service sector. And I cried out about inflation in transportation. By March 2021, it was clear to me that “something big changed” based on the fact that consumers were willing to pay a totally crazy price for a used car. Already for some time it would have lowered the market, and with it the price.

But no, consumers suddenly started paying for anything. And I suddenly recorded how companies were able to pass higher prices because everyone was willing to pay anything. And by April, producer prices had exploded and businesses were able to pass them on. And in April, I started using the term for this phenomenon: the “inflationary mindset” and the way it was suddenly established.

By that time in April, the idea of ​​inflation has been established by companies paying higher prices, being confident they can pass them, and consumers willing to pay anything. So it was clear beyond reasonable doubt that inflation would be a big problem.

And all the time-despite us screaming in trenches-as a true inflation arsonist, the federal government continues to throw large amounts of petrol into the already raging fires by curbing interest rates and printing money, its “temporary”. Would have stuck to the “genuine” nonsense.

And when the Fed finally couldn’t get rid of it in the fall of 2021, inflation continued to worsen, so the Fed verbally made a notorious pivot, but continued to pour gasoline into the fire. rice field.

Federal Reserve Board Final I started slowly It dials back the amount of petrol that was still pumping directly into the fire: it gradually reduced the QE instead of ending the cold turkey on the spot when pivoting and it 2022 instead of pulling them up Putting a price hike on the table of the year on the spot, and inflation worsened.

Policy error after policy error – with serious consequences. Quantitative easing is now shrinking, but the Fed’s policy rate is still close to 0% and CPI inflation has skyrocketed to 7.9%.

However, many of the individual categories of prices have been completely blown away, especially those where non-wealthy people spend a lot of money.

  • Used car: + 41.2%
  • Gasoline: + 38.0%
  • Gas utility: + 23.8%
  • Beef and veal: + 16.2%
  • Pork: + 14.0%
  • Poultry: 12.5%
  • New car: + 12.4%
  • Egg: + 11.4%
  • Fresh fruit: + 10.6%
  • Fish and seafood: + 10.4%
  • Electricity: + 9.0%

The most reckless Fed ever.

So now we are in this crazy situation and the Fed not yet While the CPI inflation rate is rampant at 7.9%, it will curb the effective federal funds rate (EFFR) to 0.08%, which could soon exceed 8%.

During the high inflation era of the 1970s and 1980s, CPI inflation was 7.9%, with moments rising or falling above it.

However, when the CPI was 7.9%, the EFFR was:

  • Inflation rate rises in October 1973, EFFR = 10.8%
  • Inflation rate declines in September 1975: EFFR = 6.2%
  • Inflation rate rise in August 1978: EFFR = 8.0%
  • Inflation declines in February 1982: EFFR =14.8%

And this is what this absurdity looks like, dating back to 1955, when the EFFR data began. Red line = CPI, purple line = EFFR. This chart shows why this is the most reckless Fed ever.

“Real” EFFR: Never approached recklessly. The value of the EFFR minus the CPI produces an inflation-adjusted or “real” EFFR. The actual EFFR is currently -7.8%, the lowest and worst recorded history. The most reckless federal government ever:

It will be difficult to change the Fed’s credibility as an inflation arsonist.

The Volcker Fed gained credibility as an inflation fighter in the early 1980s. This has benefited the economy for nearly 40 years. During and after the financial crisis, the Fed managed to print money without causing this type of sharp inflation. We have now.

But by sending large amounts of petrol into inflation that was already raging for over a year, the FRB was as an inflation fighter when many people, including myself, were yelling about it because it was so obvious. Wipe out trust and replace it with the world’s largest inflation arsonist. And everyone knows it.

When the Federal Reserve says it’s taking inflation control seriously, no one will believe it. Inflation is partly a psychological phenomenon, what I call the “idea of ​​inflation,” and the Fed has blown its credibility. That.

The Fed’s meme that money printing helps people work turns out to be BS.

The Federal Reserve has refused to deal with crazy monetary policy and inflation as a way to support the lower labor market, which is clearly BS. And the Federal Reserve knew that. Since April 2021, CPI inflation has increased for 11 consecutive months compared to the previous year.

In other words, “real” earnings have fallen for the 11th straight month, thanks to the Fed’s fierce inflation. This is despite the sharp rise in wages and the tight labor market of the same generation. Inflation has the greatest impact on those who make a living from real work. , Not the person sitting on the pile of assets.

That is the price of interest rate suppression and printing of money, which is paid by those who work to make a living.

But wait … there was a small group of huge beneficiaries from the Fed’s policies..

The Federal Reserve has long set “asset effect” as its official monetary policy goal. Asset effects have been advertised in many Federal Reserve papers, including when Janet Yellen was still president of the San Francisco Fed in 2005. The Fed has used monetary policy (interest rate restraint and QE) to raise asset prices and make asset holders (already wealthy) even wealthier. ..

The achievement of this asset effect doctrine, and the exponential efficiency achieved during the enthusiastic quantitative easing and interest rate restraints since March 2020, is the largest asset inequality to date.

My “asset effect monitor” is “1%”, “2% to 9%”, “next 40%”, and “bottom 50%”. My asset effectiveness monitor lowers the Fed’s data to household levels.

What the Fed should do now to mitigate the effects of reckless policy errors..

The Federal Reserve cannot undo the enormous policy errors it has made in the last two years, but it can end them in the future and the catastrophic effects currently occurring in the economy. You can mitigate and prevent those effects from becoming completely out of control.

So this is not what the Fed should do, but another story, it should be done now after the meeting on March 16th.

Start unloading the balance sheet ((((Quantitative tightening) now Both can be rolled off without exchanging all maturity securities at a rate of around $ 200 billion per month. When It must first be executed by completely selling the securities with the longest maturity, such as the 30-year bond with 29 years remaining.

Run QT in the foregroundWith The clear purpose of increasing long-term yields.. As Powell said, running QT in the “background” of the autopilot is stupid. Just as the purpose of QE was to lower long-term yields, the purpose of QT is to raise long-term yields. The goal is to steep the yield curve while the Fed is raising short-term interest rates.

Specifically, we will sell MBS completely. MBS has a maturity of 15 and 30 years. Holders such as the FRB receive a pass-through principal payment from the mortgage payment, and the mortgage is repaid by repayment of the mortgage or sale of the house. Interest rates, refis, and home sales are booming in the home market, where mortgages are declining, these pass-through principal repayments will turn into mortgages, and the FRB’s balance sheet MBS will fall sharply.

But with this Rising interest rates The environment, the housing market will slow down, refis will slow down, and pass-through principal payments will be slightly slower. As a result, the Fed needs to sell MBS altogether and get out of its balance sheet altogether within a few years.

Time the market with securities sales: Take advantage of selling opportunities every time the long-term yield drops a little More securities.. Any good investor looking to unload debt securities will do so. This keeps the yield curve steep.

Raise short-term interest rates by 100 basis points on March 16To help everyone understand that the Fed is serious about ending its reputation as an inflation arsonist and regaining its ruined confidence as an inflation fighter. After that, we will continue to raise interest rates little by little, such as 50 basis points at all meetings this year. By the end of the year, the policy rate will reach about 4.5% and inflation could exceed 8%.

Inflation may be able to recover faster by accelerating rate hikes and breaking that “inflation mindset.” ..

“FRB PutLet the market find its own way. The market is good at it. Sold out brings the coveted excess and purification of many opportunities. The market must be allowed to function as well as the market.

Remove QE from the toolbox only once.QE is a destructive policy that creates wealth inequality, asset price inflation, and ultimately consumer price inflation. The actual economic impact is minimal. You need to throw it in the trash.

Instead, use the Standing Repo Facility if the Treasury market is stagnantThe Fed may have rebuilt the repo trading facility in 2021 after closing the repo trading facility in 2008 for this purpose. No quantitative easing is needed.

Allow debt restructuring and bankruptcy to resolve excess debt If a company has too much debt, it will have to be restructured at the expense of investors. This is a healthy and essential process of capitalism. Due to two consecutive recessions, the federal government has stopped running the process. Further fueled by years of ultra-low interest rates, there is a huge excess. US law and markets are very good at organizing this.

But instead, Powell tries to design a soft landing..

Yes, the Fed raises rates and shrinks its balance sheet, but they claim they can step in and achieve a soft landing by not doing enough. The longer it gets and is dragged, the harder it is to get rid of it, and the longer it takes for the Fed to finally contain it.

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This stock market is becoming an unbonded stock on a stock-by-stock basis. The turmoil that has completely crushed the stocks one after another for a year breaks through the surface.

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