January Headline CPI increased at an accelerated rate (0.5%) and Core CPI increased by the same month-to-month rate (0.4%) as December’s increase. Food prices increased at an accelerated rate (0.5%) and Energy prices increased (2.0%) after having declined for the two previous months. Inflation is proving to be sticky (as we predicted in April 2021). Therefore, I am surprised by today’s lack of a market reaction. Persistent price inflation means weaker Real GDP, elevated interest rates, higher cost of capital and lower asset values.
2% CPI is not in the cards for this year or next – meaning prices for goods and services will remain elevated. I don’t believe the Fed is willing to fight inflation to the level necessary to get CPI back to 2%. This would require a deep and prolonged recession.
My advice to the Fed would be to spend less time on the arbitrary setting of its Fed Funds rate and instead focus on QT. In the immediate term the Fed ought to increase its QT effort beyond its self-imposed $60 billion per month Treasury ceiling and $35 billion per month mortgage-backed ceiling. I would shrink the money supply more rapidly. Start by going to $90 billion (Treasuries) and leave the MBS QT effort where it is for now. This would take the Fed’s QT effort to approximately $125 billion per month. Recall the Fed expanded the money supply by approximately $120 billion per month during the COVID QE days. I hope we never see QE again.