Neutral Rate Holds The Policy Key
Core inflation is starting to decelerate as I expected. Some economists are even projecting the cycle peak in inflation has occurred. Inflation will likely fall in the next few months along with oil. If you think the cycle peak in inflation has occurred, then it implies you’re bearish on the economy. This cycle has been so long that there have been several inflation peaks. The Fed raising rates in this environment makes no sense. The Fed thinks inflation will regain momentum next year.
The key point to realize is the Fed’s goal is to have consistent 2% inflation. In this cycle, it has only stayed near 2% temporarily when it has easy comparisons. There haven’t been 2-year stacks of 4% core inflation. Even though inflation is disappointing, you can argue that the Fed is simply trying to normalize rates.
The million dollar question is where the neutral rate is. Hawkish policy is a mistake, but it’s not clear if this rate hike in December pushes rates into that territory. That’s where rates slow the economy. Personally, I think monetary policy will slow growth in 2019. If growth slows, it will difficult to tell if it was caused by the monetary policy because there are other negative factors which will also weigh on the economy.
The only reason to cause a recession with rate hikes if you think inflation is a big problem. There needed to be a recession after the housing bubble because housing prices needed to become affordable again. They needed to be especially affordable because the unemployment rate rose.
Slightly Disappointing October CPI
Month over month headline inflation was 0.3% which matched estimates and was above the 0.1% growth in September. It was 2.5% year over year which met estimates and was above September’s rate of 2.3%. This acceleration will be short-lived because oil prices have been cratering. Energy increased 2.4% month over month in October. Gasoline was up 3%.
