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Inflation Gives Fed the Finger
James Rickards

Is inflation over? Actually, no. And it may be getting worse.

Let’s begin the analysis with the latest data. Last Friday, the Bureau of Labor Statistics reported that inflation (as measured by the Consumer Price Index, CPI, on a year-over-year basis) was 3.4%.

That’s practically the Federal Reserve’s worst nightmare.

Here’s why: The Fed stopped raising interest rates last July. At that time, they set the target policy rate for fed funds at 5.50%. Despite some internal debate, there have been no further rate hikes in the last three meetings.

In the December 2023 meeting, Fed Chair Jay Powell more or less confirmed that the Fed had reached what they call the “terminal rate.” The terminal rate is defined as a rate that’s high enough to bring inflation down on its own without further rate hikes.

This belief put the Fed on pause and immediately started speculation about the “pivot” to rate cuts in the near future.

Is There Really a Terminal Rate?

In the first place, a terminal rate is an invention by the Fed. There is no discussion of terminal rates in economic literature, and it’s not something the Fed has used before as a policy tool. The Fed just made it up.

It’s not even clear that any terminal rate even exists. Inflation can go up on its own for reasons that have nothing to do with Fed policy. Supply chain disruptions, economic sanctions, pandemics and demographics are all examples of factors that can drive rates higher or lower regardless of the Fed.

So let’s not put too much stock in the idea of terminal rates. They may not even exist except in Jay Powell’s imagination.

Even if you believe in terminal rates, the idea crashed and burned before it even got off the ground. Here are recent data points on CPI for 2023:

June 3.0%
July 3.2%
August 3.7%
September 3.7%
October 3.2%
November 3.1%
December 3.4%

A few observations. First and foremost is the fact that inflation went up in December to 3.4% from 3.1% the month before. What happened to the terminal rate and inflation going down?

Worse yet, December’s reading of 3.4% is higher than October (3.2%), July (3.2%) and June (3.0%). This shows that the December reading is not a fluke. It’s part of a pattern most of which arose after the Fed hit the terminal rate.

Inflation is not going down; it’s stuck in a range of 3.0–3.7%. Some months are higher in the range than others, but none is lower. Inflation is stuck and the December rate of 3.4% is higher than the range mid-point of 3.35%.

As an aside, if you believe these inflation rates are low, guess again. A 3.4% rate of inflation will cut the value of a dollar in half in 20 years, and half again in another 20 years. That means in an average career beginning at age 25 and ending at age 65, the dollar will lose 75% of its purchasing power. Good luck with that.

Since the December CPI marked the last month of the year, we can do some annual comparisons also. Here’s the data for annual average CPI:

2019 1.8%
2020 1.2%
2021 4.7%
2022 8.0%
2023 4.1%

Improvement? Yes and no. 2023 inflation was an improvement compared with 2022, but it has not much changed from 2021. All of the readings look horrible compared with the 1.2% inflation in 2020 (pandemic year) and the 1.8% inflation of 2019 (pre-pandemic).

In any case, the 4.1% average inflation for 2023 will cut the value of the dollar in half in only 17 years; about the time from the birth of a child to when they head out to college.

What Happens Now With Interest Rates?

Interest rates have had an interesting reaction to this inflation news. At the very short end of the yield curve, 1-month Treasury bills, rates have risen from 4.45% to 5.53% in the past year. That’s consistent with Fed rate hikes and concerns about inflation.

At the 10-year Treasury note maturity, the story is different. The yield-to-maturity for 10-year Treasury notes has plunged from 4.99% on Oct. 19, 2023, to 3.94% on Jan. 12, 2024. That 1.0% plunge in Treasury note rates in 85 days has only happened six times in the past 30 years (yields have subsequently risen to 4.14% as of today).

It shows that the note market, overall, is not worried about inflation but is worried about recession and a possible monetary crisis. If you expect recession and monetary stress, you’ll be glad to get 3.94% on safe Treasury notes. You will also expect capital gains as rates plunge even lower in the months ahead.

By the way, no sooner was the Labor Department CPI released than the Wall Street gurus and TV talking heads started pointing at other metrics. They shouted that “core” inflation (CPI excluding food and energy) had declined and was now 3.9% (annualized).

From the point of view of everyday Americans, core inflation is nonsense. Gas in the car, home heating and food on the table are a large part of the total spending of most Americans. Taking them out of the inflation calculation is something only the eggheads would do.

When Americans provide for their families, they don’t pay “core,” they pay regular CPI. That’s all you need to know when it comes to public policy, citizens’ well-being and (for politicians) how people will vote. For the record, 3.9% inflation cuts the value of the dollar in half in 18 years.

For the super-geeks, there’s something called super-core inflation. That measure of CPI removes food, energy and housing costs. It went down slightly in December. That’s good news for people who don’t eat or drive and live in a tent. I have no idea why the eggheads even bother calculating super-core. I guess they don’t have enough to do.

Bad News for Biden

Where do these inflation numbers leave us? It’s a mix of good news and bad news — mostly bad. It appears that the Fed’s notion of a terminal rate was nonsense and that inflation well above the Fed’s 2.0% target will persist for some months.

On the other hand, the Treasury note market is telling us that we may be heading into a recession. That will definitely bring inflation down later in the year but not for good reasons. Declining GDP and unemployment headed to 6.0% will subdue inflation. But that’s no one’s idea of a “soft landing.”

Another Wall Street narrative gone up in smoke.

The political implications for Joe Biden could not be worse. He will definitely be blamed for the inflation of the past three years. Even if inflation is much lower by Election Day, Biden will be tarnished with the legacy of three years of price increases.

Remember, lower inflation does not mean price declines; it just means prices are going up but at a slower rate. The damage of price increases from 2021–2023 is embedded in current price levels and will not go away.

Of course, the impact of a recession on Biden’s reelection requires no explanation.



James G. Rickards is the editor of Strategic Intelligence. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital Management L.P. (LTCM) by the U.S Federal Reserve in 1998. His clients include institutional investors and government directorates. His work is regularly featured in the Financial Times, Evening Standard, New York Times, The Telegraph, and Washington Post, and he is frequently a guest on BBC, RTE Irish National Radio, CNN, NPR, CSPAN, CNBC, Bloomberg, Fox, and The Wall Street Journal. He has contributed as an advisor on capital markets to the U.S. intelligence community, and at the Office of the Secretary of Defense in the Pentagon. Rickards is the author of The New Case for Gold (April 2016), and three New York Times best sellers, The Death of Money (2014), Currency Wars (2011), The Road to Ruin (2016) from Penguin Random House.

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