We expect a 50 basis point increase in the Fed Funds rate tomorrow. More importantly over the next number of months will be the Fed’s actions with respect to its balance sheet.
Our focus will be on the Fed’s balance sheet over the next number of months (see chart below), which has ticked down recently as the Fed prepares its QT execution. The Fed is the direct source of the inflation we are experiencing given the enormous liquidity it pumped into the market beginning in April 2020 which expanded the money supply (M1) at an unprecedented rate (see chart below). Selling Treasuries and other Government Agency securities from its balance sheet will contract the money supply and simultaneously drive yields higher – thus tightening monetary policy. These actions will dampen inflation over time.
When CPI figures are released on May 11th we expect the headline number to come down from March’s 8.5% level given that the price of oil came down in April from March. However, we expect food, shelter and other key elements to march higher sequentially for the foreseeable future. Food prices in particular seem to know no upper bound. We believe the Fed will increase its target CPI from 2% in the coming months.