Pro Perspectives 9/22/22

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September 22, 2022

Remember, yesterday we looked at the Fed's recent economic and policy projections.
 
In these projections, the Fed painted a pretty gloomy picture: ultra-low growth, rising unemployment, and what would be a stifling increase in interest rates into the end of the year.
 
As we discussed yesterday, if they were to follow through on this outlook, they would bury the economy into a deep recession.
 
But keep in mind, these projections are part of the Fed's "forward guidance" strategy.    
 
And "forward guidance" is an explicit tool, at the Fed's disposal (just like interest rate setting), intended to manipulate behaviors.
 
What behavior do they want to manipulate?  Hiring. Spending. Investing. Confidence.  Mostly, they want all of this to manipulate the "expectations" of where inflation is going.  
 
Remember, the Fed is far more concerned about inflation expectations, than they are about inflation.  If they lose control of expectations, people start pulling forward purchases, in anticipation of higher prices, creating a self-fulfilling upward spiral in prices. 
 
On that note, they are winning.  This next chart is their favored gauge on measuring inflation expectations.  
 
As you can see, there was a spike in inflation expectations early this year.  That spike peaked in April.  This happened as the Fed was making the first rate hike (moving away from zero rates).
 
The Fed's fear at that time, was a continuation of that spike (both the rate of change, and the rising level of expectations).  But as you can see to the far right, inflation expectations have since been very tame.  And that's tame relative to history, despite the forty-year high in inflation.
 
Powell said as much yesterday:  "Despite elevated inflation, longer-term inflation expectations appear to remain well anchored." 
 
So the Fed is winning, in that they've successfully killed the animal spirits in the economy.  We can see it in the deteriorating economic data.  We can see it in lower trending price data.    
 
I suspect yesterday's use of "forward guidance" was intended to secure a little more demand destruction (a little more power in the punch).