The small news of the week was that the Federal Reserve paused its interest rate death march in the wake of allegedly dovish news on consumer and producer prices.
The bigger news is that if one probes further, these reports tell us that America’s working and middle classes are likely looking forward to several more years of persistent inflation, relatively high interest rates and subpar economic growth, in other words, stagflation.
To understand why this may be so, let’s make the clear distinction — as both economists and the Federal Reserve do — between core inflation and non-core inflation, the total of which provides the overall "headline" rate of inflation.
This distinction is important because the Federal Reserve primarily bases its monetary policy decisions on whether to raise or lower interest rates on trends in the core rate alone.
Core inflation is simply the overall inflation rate minus non-core food and energy prices. Economists like to omit non-core inflation in monetary policy decisions because, in most cases, food and energy prices are driven more by exogeneous supply shocks than movements in the business cycle.
For example, both food and oil prices spiked with the Russian invasion of Ukraine because oil supplies were disrupted, Ukraine is one of the world’s most important wheat growers and "breadbaskets," and oil is a key contributor to fertilizer and therefore food prices.
More generally, food prices tend to rise and fall with things like weather conditions whereas energy prices are often knocked off course by exogenous shocks, e.g., an oil embargo in the 1970s.
The other fact useful to lay the predicate for the case that stagflation is likely here to stay for a while is this: Since the spring of 2022, the Federal Reserve has increased short-term interest rates by about five percentage points and today the Fed funds rate stands at about 5% — up from virtually zero in April of 2022.
Here’s the key point: Even if the Fed continues to pause interest rates, as it has done this week, the current level will continue to choke business investment, gouge consumers now saddled with significant credit card debt, and severely constrain a homebuyer’s market for which 7% mortgage rates are a dealbreaker.
So what exactly did we really learn this week from the latest inflation numbers?
On Tuesday, June 13, the consumer price index hit the bull’s-eye on market expectations, coming in with a headline rate of a mere 0.1% in May while the annual rate of inflation slowed from 4.9% to 4%, the lowest since March of 2021.
Wednesday provided similar news on the Producer Price Index, with wholesale prices falling 0.3% in May, the third drop in four months and beating forecasts.
But here was the buried lead: Core inflation remains stubbornly high at 5.3% – more than twice the 2% Fed target.
Just how long will it take to get core inflation down to 2%? The answer is grim: certainly not days, likely not months, and almost certainly several years.
What that means as a practical matter is this:
On the one hand, if the core cools further, it will do so slowly, and any Fed rate cuts back down towards zero where this whole mess started will take a long time.
On the other hand, if core inflation rekindles, as it well might because of the massive overspending by the Biden regime and associated demand-pull inflation pressures, the Fed may have to resume its rate hikes.
In fact, that is the more likely scenario as another two rate hikes are already baked into the markets by the end of the year based on Fed Funds Futures activity.
In other words, Wall Street clearly believes the inflation battle is far from over.
Reinforcing this expectation of more rate hikes, only four members of the Fed’s decision-making body expect just one more hike while nine expect two more hikes, and two expect three more; and only two members thought the Fed was done for the year!
And that is where we stand.
Under this punitive Fed policy, Main Street will continue to get clobbered while the smart money on Wall Street will bask in billion dollar profits as they, with the help of their new artificial intelligence bots, skim money off your 401(k)s as they go alternately short or long to navigate these nasty shoals.
Given these uncertainties, cash remains a good place to be for the cautious as the broad stock market index, the S&P 500 continues to trade near the top of its range with little volatility.
In competing views of this market, many on Wall Street remain bullish as the S&P 500 has bounced up 20% off its October low.
Yet, analysts at Morgan Stanley are looking for a bear market predicated on a fall in real corporate earnings as inflation, particularly wage inflation, erodes profit margins.
That view is far more in tune with the stagflation scenario we have just diagnosed.
(A related article may be found here.)
Peter Navarro holds a Harvard Ph.D. in economics. One of only three senior White House officials to serve with Donald Trump from the 2016 campaign to the end, Peter was chief China Hawk and manufacturing czar. White House memoirs include "In Trump Time," and "Taking Back Trump’s America." His website is peternavarro.com - Read more reports by Dr. Navarro — Here.
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