The Federal Reserve Will Declare a Premature Victory Over Inflation


CFA, Chief Investment Strategist

The Federal Reserve (Fed) created a monetary policy exit ramp at the Jackson Hole Economic Policy Symposium in August 2020 and they may be about to use it. Back then, the Fed formally agreed to a policy of “average inflation targeting,” meaning that it would allow inflation to run “moderately” above the 2% goal “for some time” following periods when it had run below that objective.

The challenge for investors is that the Fed cleverly didn’t provide much guidance on how hot it would allow inflation to run — or for how long. But we’re all about to find out.

Living with Inflation Above the 2% Target

Despite the Consumer Price Index (CPI) hitting 40-year records, the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) Index excluding food and energy, has slowed each month since peaking in February, falling from 5.3% to 4.7%.1 The University of Michigan’s long-run consumer inflation expectations measure also slipped from 3.3% to 3.1%, easing fears that soaring inflation was becoming dangerously entrenched.

The Fed’s interest rate hikes in March, May, June and July — with more expected at future Federal Open Market Committee (FOMC) meetings — combined with slumping commodity prices, including for oil, will likely lead inflation barometers to fall further. Exactly the outcome the Fed desires — stable prices.

Figure 1: Conference Board US Leading Economic Indicators

Figure 1: Conference Board US Leading Economic Indicators

Yet, despite the PCE Index’s recent deceleration, continued aftershocks from the global pandemic (i.e., supply chain bottlenecks, rising wages and skyrocketing rents), the Russia-Ukraine war and China’s unwillingness to ditch their zero-COVID policy will likely keep inflation above the Fed’s target.

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Bureau of Economic Analysis, June 30, 2022.

US Department of Labor, July 28, 2022.

National Association of Realtors, July 20, 2022.

4 Dan Burns, “U.S. home builder sentiment plunges, services activity in New York region stalls.” Reuters, July 18, 2022.


Consumer Price Index (CPI)

Inflation measured by consumer price index (CPI) is defined as the change in the prices of a basket of goods and services that are typically purchased by specific 
groups of households.

GDP Gross domestic product is the standard measure of the value added created through the production of goods and services in a country during a certain period.

Inflation An overall increase in the price of an economy’s goods and services during a given period, translating to a loss in purchasing power per unit of currency. Inflation generally occurs when growth of the money supply outpaces growth of the economy. Central banks attempt to limit inflation — and avoid deflation — in order to keep the economy running smoothly.

NFT A non-fungible token is a digital asset that links ownership to unique physical or digital items, such as works of art, real estate, music, or videos.

SPAC A special purpose acquisition company is a company without commercial operations that is formed strictly to raise capital through an initial public offering (IPO) or the purpose of acquiring or merging with an existing company.

Originally Posted July 28, 2022 – The Federal Reserve Will Declare a Premature Victory Over Inflation


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