This post The Most Momentous 72 Hours in Fed History appeared first on Daily Reckoning.
A 72-hour span last week was among the most momentous for the Federal Reserve in the over 100-year history of the U.S. central bank.
Many Fed watchers would be completely baffled by that statement.
Fed watchers are mesmerized by minute changes in grammar and syntax contained in the statements of the Federal Open Market Committee (FOMC), the Fed group that sets interest rates.
At the last Federal Open Market Committee (FOMC) meeting, on July 26, the Fed did nothing. The Fed’s Jackson Hole, Wyoming, summer meeting came and went at the end of August with scarcely a word said about interest rate policy. The next FOMC meeting is not until Sept. 20. In short, we’re in the midst of a rare period when nothing seems to be going on at the Fed in terms of rate policy.
How could last week have possibly produced a momentous 72-hour period?
The answer is that institutions boil down to people, not calendars, and Fed people have just made a lot of headline news.
Last Tuesday morning, Sept. 5, Fed governor Lael Brainard delivered one of the most significant Fed speeches ever. Translating from Fed-speak to plain English, she more or less admitted the Fed has no idea how inflation works.
Brainard pointed out that the Fed began its current monetary policy tightening cycle in the belief that tight labor markets implied inflation was coming with a lag. The Fed raised rates in December 2015, December 2016, March 2017 and June 2017 in part to get out ahead of this coming inflation.
Instead the opposite happened.
The Fed’s favorite measure of inflation plunged from 1.9% to 1.4% between January and July 2017 even as job creation continued and the unemployment rate fell. In other words, the relationship between tight labor markets and inflation turned out to be the exact opposite of what the Fed believed. Their models are in ruins.
Of course, this is what I’ve been telling my readers to expect all year. The Fed was tightening into weakness, not strength, and would soon have to flip back to ease in order to avoid an outright U.S. recession. And ease is exactly what Brainard called for in her speech. Brainard had a three-part remedy for disinflation…
The first part was the use of forward guidance to signal that Fed rate hikes were on hold indefinitely. This is a form of ease relative to market expectations of further hikes.
The second part was to raise inflationary expectations by making public statements about the forward guidance. This is similar to the “Think System” used by Professor Harold Hill in the musical The Music Man.
Hill is a con artist who sells instruments to school kids. He can’t teach music but tells the kids if they will “think” hard enough, they can play! Brainard says if we all think inflation is coming, it will come. Her odds of success are about the same as Professor Hill’s, who is almost run out …read more
Source:: Daily Reckoning feed
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