MacroResearchBoard

Inflation Mistake #2? – December 18, 2023

A just-published report highlighted that the Fed is on track to commit yet another mistake with regards to underestimating inflation.

Last Wednesday’s FOMC meeting marked a meaningful pivot in the Fed’s policy stance, as the Fed clearly signaled that it is considering easing policy. It is not anticipating a recession, but the Fed believes that the ongoing moderation in inflation will justify lowering the policy rate to a more “normal” level, which to the Fed are the levels that prevailed in the 2010s. However, we think that such low rates are no longer appropriate.

In contrast, our view is that the U.S. economy will not warrant rate cuts next year, and that the Fed is too complacent on inflation. Services inflation is still too elevated, and wages are still growing faster than in recent decades. Moreover, by indicating an intent to cut rates in 2024, the Fed has unnecessarily spurred even easier financial conditions. The consequence is that economic growth won’t slow much at all next year, which means that inflation will eventually firm anew and surprise the Fed.

The recent Fed pivot will prove counterproductive down the road, but should help to sustain the Goldilocks investment environment for a while longer.