Inflation Data is Promising; What Will the Fed Do Next?

I am 61 years of age. Being “old” certainly has its disadvantages, but it does at least give one the benefit of having seen a lot of things before, including, for me, having lived and traded through multiple recessions, “crises,” and even periods of double-digit inflation. I have thought back to those times in the 1980s quite often as the Fed battles inflation for the first time in decades, but I have concluded that my experiences are of limited value in assessing what is happening now. Put simply, this time is different, and recently released economic data show why.

Over the last couple of days, we have seen the April numbers for CPI and PPI, the measures of inflation at the consumer (CPI) and producer (PPI) levels, as well as weekly jobless and continuing claims. In many ways, even with the debt limit saga once again playing out in Congress and continuing concerns about the stability of regional banks, these are the most important data in the current situation. The market is concerned that the Fed’s rate hikes, designed to combat inflation, will lead to a recession, and it is the ebbing and flowing of that fear that is driving stock prices. In the past, deliberately engineering a recession has been the only way to beat inflation, so the assumption had been that we'll need a recession here as well. However, that may not be the case this time around, but that doesn’t mean we are home free.

Fed Chair Jay Powell hinted this month that the central bank may pause the rate hike cycle but, as we have become accustomed to hearing, that decision will be based on the data. Nothing new there. For a while now, the favorite phrase of Fed Chairs and FOMC members has been “data dependent.” It was used a lot by Janet Yellen and has now been adopted as a catchphrase by the board led by Jay Powell. It isn’t hard to see why. It is almost impossible to criticize somebody for saying that their decisions will be driven by hard, empirical evidence, but there is a problem with that. As Mark Twain said in Chapters from My Autobiography there are three kinds of lies: “lies, damned lies and statistics.” Or to put it more kindly, numbers are always subject to interpretation.

The core numbers that strip out the normally volatile food and energy sectors for both CPI and PPI came in above the Fed’s target rate, so the argument can easily be made that the war is not yet won, and further hikes are needed. On the other hand, both also continued a trend of steep declines in price rises that have been in place since March of last year, and a look at the chart for PPI would suggest that we are only a month or so away from hitting those targets. A pause at these levels would therefore be not only justified, but possibly even necessary:

The difference between now and the 1980s when inflation was so stubborn, is that there is an obvious reason for the jump in prices this time around. The pandemic prompted an unprecedented economic shutdown and disrupted supply of raw materials for two years, as you can clearly see on the above chart. The extended period of ultra-low interest rates that followed the 2008/9 financial crisis probably made the impact of that greater than it otherwise might have been, but the root cause of the problem is pretty obvious when you look at the timing.

That inflationary pressure, though, has passed. Market forces are doing their thing, with higher prices encouraging greater production, increasing supply, and bringing prices down. If anything, the data now indicate that Powell was right all along in that inflation was essentially transitory. With both consumer and producer price increases slowing to within the normal range, and jobless claims ticking up to suggest that the jobs market is cooling and wage pressure is declining, further increases in interest rates look unnecessary at best and even potentially harmful.

Or at least, that is one interpretation of the figures.

Powell and the others at the Fed could see it another way, that this is proof their policies are working and therefore a reason to continue with the hikes. That will be a tempting proposition for the Chair, who believes that his legacy will be based on how he manages the fight against inflation. If that is at the top of his mind, and the examples of the 1980s tell him that history will forgive him if achieving that means forcing a recession, the data can be used to justify further increases, too. 

I’m beginning to see what Twain meant. Statistics, seemingly indisputable facts, can be used to justify two diametrically opposed courses of action, and which it is depends on the interpretation of them by one man. That makes predicting market moves just about impossible, but at least the numbers show there is hope that we won't invoke a recession to beat back inflation.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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