Opinion - Markets

Ron Insana: The Fed is still intent on taking the punch bowl away when the party is long over

Federal Reserve Board Chair Jerome Powell holds a news conference after the Fed raised interest rates by a quarter of a percentage point following a two-day meeting of the Federal Open Market Committee on interest rate policy in Washington, March 22, 2023.
Leah Millis | Reuters

Judging from the Federal Reserve's most recent statements and actions, the Fed may well be following the immortal advice of Nike and planning to "Just do it!"

It seems they still want to drive short-term interest rates to their presumed terminal level, now almost universally believed to be 6%, or a full percentage point above its most recent target of 4.75-5%.

A host of prominent economists say the inflation fight is far from over and, whether riding the Phillips Curve or adhering to the Taylor Rule, the Fed ought to push forward and get real interest rates above the declining inflation rate to kill post-pandemic price increases once and for all.    

It doesn't seem to matter that domestic and global banks remain under duress as the latest worries about bank solvency put Deutsche Bank in the crosshairs on Friday.

As was the belief in 2007, officials say the banking system is sound and there are few indications of systemic risk from the failures of Silicon Valley Bank, Signature Bank and continued troubles at First Republic.

Small banks have a reported $270 billion in commercial real estate loans that are likely going to be pressured as the economy weakens, complicating the outlook for credit availability in the months ahead.

The Fed acknowledged that recent bank troubles could lead to tighter credit conditions and make business and consumer loans more difficult to get.

The Fed apparently doesn't mind that since it helps the Fed slow the economy and put the inflation genie back into the bottle.

Never mind that a recession, with risks rising every day — look at the yield curve, leading economic indicators, real estate activity and manufacturing all contracting — is looming large in the second half of 2023.

If I were at the Fed, I'd mind.

Inflation coming down fast

Global interest rates are plunging, and gold has been surging in a flight to quality, not a flight to hedge against inflation.

It should matter that Rent.com shows residential rents have plunged from an 18% year-over-year gain in early 2022 to less than a 2% year-over-year advance last month.

Owner Equivalent Rent, the housing cost proxy used in calculating consumer prices, accounts for 25% of CPI and 12% of the PCE Deflator, the Fed's favorite inflation gauge.

Shelter costs accounted for 70% of last month's larger-than-expected CPI increase, based on old rent data.

Looking farther out into 2023, rents should put significant downward pressure on inflation, as Fed Chair Jerome Powell, himself, admitted at this week's news conference.

Energy prices, including oil and natural gas, continue to slide, in the case of natural gas, plunge, driving down consumer energy costs, which will likely drive inflation down even further, given a 9% weighting in the CPI.

Goods inflation, again, as Powell admitted, is in disinflationary mode.

Service sector inflation lags goods inflation and that's starting to show up in earnings calls at airlines, many of which suggested a slowdown in travel later this year.

Wage inflation also appears to be peaking. Rising wages seem to be the bane of the Fed's existence, even though much of the wage gains we've seen of late are compensating for decades of underpayment in a wide variety of industries.

The Atlanta Fed's wage tracker shows a peak in wage inflation at 6.7% in August of last year, falling to 6.1% as of last month.

While it's true that the unemployment rate, at 3.6%, is close to 50-year lows, it's also true that the labor force participation rate remains below pre-pandemic levels and constraints on immigration are keeping the demand for workers artificially constrained … something higher interest rates simply can't fix.

This is not the 1970s

A new paper by former White House economic advisor, Peter Orszag, now at Lazard, and fellow economist, Robin Brooks, argued this week that inflation may well be "transitory," as goods inflation has collapsed, and service inflation may soon follow.

They argue almost all of the inflation spike we've seen since 2021 was induced by the pandemic and the war in Ukraine, an argument I've been making for many months.

I worry, as I have since the start of this tightening cycle, that the Fed is using the 1970s as a template for today's policies.

But past is not always prologue.

Having said that, history may well repeat if the Fed continues to go too far and breaks more than just a few regional banks.

They should get ready to pivot just as they have after every policy mistake they've made through the course of my 39-year career.

The Fed, sadly, does not seem ready for that.

Instead, it appears to be a tracing out a well-worn pattern of taking away, not just the punch bowl, but also the hangover remedy, long after the party's been broken up.