Burn-it-All-Down Powell Claims Inflation Will be Transitory and Promises to Increase it with More Easing!

Fed Chair Jerome Powell, offered some pretty peculiar surprises at the Fed’s FOMC meeting today, but not in interest policy. While the Fed held steady on actual interest rate policy as everyone was certain it would, it did offer the stock market some candy by indicating in its dot plots that there may be two more rate cuts coming later in the year. That is not policy, but just a belief; however, it’s an odd belief at a time when inflation has been rising for months now. Why would they think they are going to cut rates further in a year when they say they also think inflation will start running hotter? It’s even more peculiar when you see the rest of what they say.

Of course, the dot plots are just the individual guesses of Fed members as to where they think their own rates will go, and they were probably inclined to want to show some optimism about the economy. After all, they said they thought GDP would be 1.7% (median), which is pretty optimistic compared to where their own Atlanta branch is estimating it will come in—still hunkering down in the basement, but back out of the sub-basement:

Federal Reserve Bank of Atlanta

I guess they don’t listen to those Atlanta guys much. No reason to because they are usually off, too. The Fed’s median estimate for its future rates has also almost always been off, usually by more than I am when talking about their future rates, which I point out now only to note that it is odd that the Fed members are routinely off since they are the ones who will be setting those rates. You’d think they might know their own minds a little better than I do as to what they are likely to do in the future, and you’d think they would know the economy they seem to be in charge of managing for all of us a little better than they apparently do. Unless, they sometimes venture guesses that they know are off for the sake of stirring a little thrill for the market.

Backing off on the QT inflation brake

Anyway, one small surprise (aside from their naive belief that they will be able to lower rates two more times) was that they decided to all but end quantitative tightening. QT is the means by which the Fed refuses to refinance some of the bonds it is holding and just collects their face value from the government upon maturity. When the Fed first bought the bond, it created money out of thin air as a liability on its balance sheet. This newly unminted money immediately became an asset on the balance sheet of the bank that sold the bond to the Fed. That’s how they did QE: Create money out of nothing to buy bonds from banks because the Fed has the authority vested in it by congress to create money.

Under QT, the Fed receives the government’s payoff of the bond, losing the bond as an asset and gaining electronic cash from the Treasury, and just wipes an equal amount off of electronic cash off the liabilities it created to purchase the bonds, evaporating the money that was creating out of nothing in the first place. This presses the government to turn to the private sector to get a new bond since the government always needs more debt these days than it already has, while the Fed is no longer buying as much.

Since reducing its balance sheet via QT reduces liquidity at banks because they wind up financing the government’s replacement debt out of their reserves with the Fed no longer buying those bonds off of them, QT has the effect of tightening up finance overall. Today’s unscheduled termination of QT looks like a bit of a sudden rescue move for stocks. Now that stocks have been crashing, it appears the Fed wanted to do something to cut them a break, which probably explains why they are going to maintain a token amount of continuing Treasury QT. That way they can just call this a “taper” and claim they are still doing Treasury QT but just easing off the inflation brake. Let’s just call that another Powell put since that was its effect on stocks today, as he and all Fed members clearly knew it would be.

The Fed states their rationale this way, though, because they’d never admit to rigging markets upward:

The Fed has outlined the reasons for slowing QT in prior communications: It now sees a risk that the massive liquidity flows around debt-ceiling dynamics, which affect the liabilities on its balance sheet, will mess up the indicators it uses to determine if QT has sufficiently reduced the reserve balances on its balance sheet to be near “ample.” The Fed has already shed $2.2 trillion in assets since it started QT in July 2022.

Whatever.

$2.2-trillion removed is a long way short of how much they pumped their balance sheet up. Since the Great Recession rescue that never ended, they have been heaping it up from a starting level of $1-trillion to a peak of $9-trillion. Now, it is just below $7-trillion. The latest QT regime had tapered from rolling off bonds at an original rate of $60-billion per month (starting in May of 2022) to $25-billion (starting in May of 2024) and now to $5-billion (starting in April). Mortgage-Backed Securities, on the other hand, will continue to roll off at the same rate of $15-billion per month.

Fed admits inflation is rising … and decides to raise it some more

Another small surprise from the Fed was that the committee members admitted that inflation is going to continue to rise. It is not a surprise, of course, that inflation will be rising, but just a surprise that they admit it, even as they say they think they will be doing more rate cuts later in the year. (I’m not sure they actually believe they will be doing more rate cuts, or just thought, now that the market is in crash mode, Why not throw a few peanuts to investors right now because it doesn’t cost us anything in terms of actually policy to guess that we’ll be making some more rate cuts? In which case, this was kind of a clandestine second put in the market.)

In other words, “We know inflation will be rising, but we’re going to goose it a little anyway.” It appears the Fed members are more concerned about recession.

The committee members raised their median estimate for core PCE inflation—the Fed’s favorite metric—at the end of this year from 2.2% to 2.8%. (Actual core for January was already back up to 2.6%.) They also raised their estimate for headline inflation from 2.5% to 2.7%. So, they admit they are going to start to lose the battle at a slightly faster rate than they already are. In other words, they agree with me now that the dawning recession is going to be stagflationary. Maybe even by design since they see themselves lowering interest rates more anyway.

Powell acknowledged that tariffs are already impacting the economy and have factored into economic forecasts. In fact, he said that the Fed has also factored in Reciprocal tariffs! Notably, and much to the anger of the left-leaning press corps, he said the base case remains for tariffs to have a transitory impact on inflation, but there’s a lot of uncertainty about that.

“Transitory,” huh? There’s another surprise—again, not in policy, but that they have the temerity to use that word again and even in the context of talking about inflation, (versus using it to talk about transitory tariffs). Let’s hope this time inflation turns out to be a lot more transitory than their last period of transitory inflation that they are still fighting while losing the battle by their own admission. It’s hard to see how it will be when they are deciding to goose it a little, and it was rising without that help.

Powell said at the Fed’s press conference that inflation resulting from tariffs could be “transitory,” but he also said further progress in reducing inflation this year could be delayed as a result of the levies. (Barron’s)

Powell should have been laughed out of the room for daring to bring that word up again, which he ultimately admitted last time was a term that was “not helpful.” Well, he’s just unhelped his future self a lot. Put that in my bag of predictions. Furthermore, they haven’t actually made any progress this year, so they should have been laughed talking about “further progress,” too.

Let me sum this up: Powell believes tariffs are inflationary, and he knows consumers believe the same thing, but his Fed is going to keep cutting interest rates and slow down QT to almost a full stop on the Treasury side right as the tariffs go into effect. But here’s the best part:

The Fed chair noted that according to recent surveys, consumers are pointing to tariffs as a reason they expect higher prices in the short term. But Powell continued to stress that longer-term inflation expectations are well anchored, meaning consumers aren’t anticipating prolonged increases in prices.

Wow! He should get the Burn-the-Banks Bernanke Award, which goes to people who can’t see really big things even when they are standing in the middle of them like Bernanke and his great recession. Powell has said many times that consumer expectations of rising inflation tend to drive actual inflation higher. As reported in my last Deeper Dive, consumer inflation expectations looking forward for a few years are already anticipating the greatest rise ever recorded under expectations:

The anticipated inflation for a year forward has moved up to 4.9%. The consumer outlook for 5-10-year inflation has jumped to the highest increase since 1993!

How “long-term” do you need Powell? The highest expected increase in decades for 5-10 years down the road is well anchored?

Since Powell can’t be going to our future 51st state to get the consumers’ temperature reading on inflation expectations because news from Canada just said inflation is rising as bad as it is here, what on earth did he carve his consumer-anticipation belief out of?

Based on that eye-ball-spinning error, which completely misses news that has already been a big headline for consumer expectations, I’d have to say Powell’s second attempt at proclaiming “transitory inflation” is going to be a bigger face plant than his first one was because, as I pointed out back then: If the Fed believes the current rise in inflation is transitory, it will be way too slow in fighting it and way too weak.

And we just saw that play out with their choice to cut QT way back and their projection of rate cuts continuing ahead.

So, I guess it’s full steam ahead into transitory inflation as far as the eye can see!

********