There was a positive reaction by the financial markets to Federal Reserve Chairman Powell’s comments on Wednesday this week. He said, “The time for moderating the pace of rate increases may come as soon as the December meeting.” The last four rate hikes to the fed funds rate have been 75 basis points (0.75%), so he is indicating a rate hike of 50 or 25 basis points at the conclusion of the Federal Open Market Committee meeting on December 14. The current fed funds rate target is 3.75-4.0%.
The financial markets paid less attention to Chairman Powell’s other remarks, which reflect the Federal Reserve’s concern of reducing inflation. After his comment about the December rate hike, he said, “History cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”
Goldman Sachs strategists are forecasting a peak federal funds rate of 5.25% in May following a 50 basis point hike on December 14 and three more 25 basis point hikes next year. Most economists expect inflation to trend lower as interest rates peak and supply constraints ease.
Rob Arnott, Partner and Chair of Research Affiliates and his partner, Omid Shakernia, recently published an article, “History Lessons: How ‘Transitory’ Is Inflation?” The full article is located here: https://www.researchaffiliates.com/publications/articles/965-history-lessons. Their conclusion is contrary to the consensus. They cite a meta-analysis of 67 published studies on global inflation and monetary policy by Havranek and Ruskan (2013) which found that across 198 instances of policy rate hikes of 1% or more in developed economies, the average lag until a 1% decrease in inflation was achieved was roughly 2 to 4 years.
Arnott and Shakernia conducted their own study and examined all cases where inflation surged above 4% in 14 OECD developed economy countries from January 1970 through September 2022. Their study focused on the level and trend of inflation. Their conclusion had the following key points:
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The US Federal Reserve Bank’s expectations for the speed of reverting to 2% inflation levels remains dangerously optimistic.
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An inflation jump to 4% is often temporary, but when inflation crosses 8%, it proceeds to higher levels over 70% of the time.
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If inflation is cresting, inflation levels of 4 or 6% revert by half in about a year. If inflation is accelerating, 6% inflation reverts to 3% in a median of about seven years, threatening an extended period of high inflation.
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Reverting to 3% inflation, which we view as the upper bound for benign sustained inflation, is easy from 4%, hard from 6%, and very hard from 8% or more. Above 8%, reverting to 3% usually takes 6 to 20 years, with a median of over 10 years.
Arnott and Shakernia believe that the consensus view that a short “transitory” period of high inflation will soon pass places too high a probability on the best case and ignores economic history.
If you have any questions or comments, please contact me.
Sincerely,
Robert G. Kahl
CFA, CPA, MBA