A Quickie on Fed Easing with Rising Inflation?

Since 1970, the Fed has frequently began easing even though the CPI Inflation rate was rising. They should do so again today.

Last week the Federal Reserve appeared very concerned about recent upticks in various inflation measures. They finally decided to ease the Funds rate by another quarter point but severely paired back the number of expected rate cuts for 2025 to only two. The most recent Fed outlook has seemingly been greatly impacted again by inflation fears.

As the accompanying chart shows however, since at least 1970, the Fed has often – indeed usually -- “eased into a rising inflation rate”. Of the 8 major easing cycles since 1968, during 5 of these previous cycles, the Fed began cutting the Funds rate only to see the annual rate of CPI Inflation accelerate. Sometimes these were fairly aggressive inflationary accelerations – e.g., 1974, 1980, 1990, and 2008. Despite easing into rising inflation, the Fed did not pause nor slow their easing campaigns during these past cycles as they have today. Fortunately, they kept easing because in every case during these previous 5 cycles, the economy ultimately headed into a recession despite ongoing Fed easing.

The most recent uptick in the annual rate of CPI inflation can only be seen in the accompanying chart if you squint with a magnifying glass. The current annual rate of inflation has increased to 2.7% in November from 2.4%. However, the CPI rate is still decelerating form July when it was 2.9%. The SPGSCI U.S. Commodity Price Index is off by almost 35% from its highs in mid-2022, both gasoline and crude oil prices are nearing a 3-year low, and the Atlanta Fed Wage Growth Tracker continues to steadily decelerate from its highs in early-2023. The 10-year Treasury Bond Yield has risen by more than 90 basis points since mid-September, the real trade-weighted U.S. dollar has spiked by more than 6% since September and is close to its all-time record high in 1984, and the annual rate of growth in the M2 money supply is only 3% which is 2% less than the rate of nominal GDP growth! Seemingly the Fed is currently being spooked by a nonexistent runaway U.S. inflationary problem. The Fed needs to give up the post-pandemic inflation ghost and see if they can keep the economy out of a recession.

The U.S. Citi Economic Surprise Index has recently dropped from about 45 in mid-November to only 10 currently and appears to be headed negative in the coming month. The current real Fed funds rate is still 1.6% compared to its average since 1960 of only about 1%. As it has during the previous 5 cycles when it began easing while inflation kept rising, the Fed should currently keep lowering the Funds rate. This time, if the Fed does not pause, there is a good chance a recession can still be avoided.

Thanks for Taking a Peek! Jimp

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