The consensus seems to be that the Fed will cut interest rates in 2023. The 1970’s illustrate how inflation could run out-of-control should the Fed prematurely reverse course on its tightening cycle.
Priority One: The Fed wants to avoid out-of-control inflation at all costs. Our view is that Fed Chair Powell will be willing to tighten monetary policy into a recession in order to curb inflation. Powell will not stop tightening until inflation as measured by the CPI slows. Powell will not achieve the Fed’s 2% CPI target, but he likely will keep the Fed on its tightening course until the CPI persists on a downward trajectory.
Dual Motivation for Powell & the Fed:
The mid-terms are coming: The mid-term elections are around the corner and President Biden would like nothing more than to point to progress as it relates to reducing inflation as measured by the CPI. The Biden Administration will continue to apply pressure to the Fed, “encouraging” Powell & Company to remain steadfast in their effort to tame inflation (The Fed is not independent and is increasingly politically-motivated).
Arthur Burns part deux: Chairman Powell does not want to repeat the mistakes of former Fed Chair Arthur F. Burns who led the Fed from January 31, 1970 – March 8, 1978. If Mr. Powell is not already the worst Fed Chair in history, Mr. Burns takes the cake with his sanguine outlook on inflation during the 1970’s. Chairman Burns – like Chairman Powell – also believed that inflation was transitory. The Fed under Burns was slow to address inflation and prematurely relaxed its tightening effort, allowing inflation to spiral out-of-control (see the below graphic which plots CPI against the Fed Funds Rate from January 1970 – January 1983). Thus, we expect Powell and the Fed to continue to tighten until inflation comes down materially (but well above the Fed’s 2% target), in order for Powell and the Fed to salvage the last vestiges of their credibility.