The Fed’s tightening is as much about its quest to regain credibility as it is about curbing inflation.
The fact that prices for goods and services started to climb in 2020 and have persisted higher for two years is no surprise. The Treasury (subsidized by the Federal Reserve) mailed trillions of freshly-printed U.S. Dollars (helicopter money), to millions of Americans. Anytime the Fed inflates the money supply it devalues the Dollar which makes goods and services more expensive. If newly printed Dollars are not directly tied to productivity (as was the case with the helicopter money and the Fed’s QE program), prices for goods, services and financial assets will climb higher. Supply-side woes have only exacerbated the price increase problem.
The Fed is embarrassed by their policy mistakes. It continued to buy Treasuries and Government Agency securities at a rate of $120 Billion per month through Q1 of this year in an effort to maintain low rates and to grow the money supply (M2 has only declined approximately $400 Billion from its $22 Trillion high. I would like to see that figure decline much more sharply). Chair Powell and Fed Governors used the word “transitory” to describe inflation countless times in the media. These mistakes were enormously embarrassing for Powell and the Fed.
Powell is embarrassed. Therefore, even though apartment demand suffered its first negative Q3 in 30 years, even though used car prices are starting to roll over, even though jobless claims are up, even though the strong Dollar is hurting Western Europe, the Fed is not going to stop tightening. Powell and Company will point to Core CPI as to why they should continue to increase rates. The Fed will point to inflation in the 1970s and how Chairman Arthur Burns failed to tighten enough, allowing inflation to resurface. The Fed under Powell won’t stop until the U.S. credit markets freeze or until they get the reported CPI figure close to the 2% range. Further, once the Fed does stop increasing its policy rate, I do not expect rates to start to come down. I believe the Fed will hold them at a plateau level throughout 2023 and into 2024.