It will be difficult to control this inflation

It’s like breaking a dam. Now interest rates and mortgage rates are higher for much longer, with asset prices falling, as the “everything bubble” is re-priced.

Written by Wolf Richter. This is the transcript of my podcast recorded last Sunday, The Wolf Street Report.

So now the media is suddenly focusing on this big problem that I’ve been screaming about for months: Inflation has shifted from energy and goods tangled up in supply chain issues to services that have no supply chain issues.

A great example is insurance. I guarantee you there is unlimited, yet health insurance costs have gone up 24% over the 12-month period, and auto insurance has jumped 9%.

It’s little things, too. It just got a 20% increase in the broadband service I signed up for a year ago to replace Comcast, which doubled its monthly fee a year ago.

Prices for other services have also jumped. Vehicle maintenance and repairs are up 9%, rents are going up, all kinds of providers are raising their prices, and consumers are paying for them.

This is inflated services. Most of it has nothing to do with energy and supply chains.

However, gasoline prices have fallen from their June highs, many supply chain issues that have led to some commodity price hikes have been resolved, and many commodity prices have fallen.

So now we are dealing with inflation in services. This type of inflation means that something has seriously changed in the economy, and how the participants in that economy – that is, consumers, businesses and governments – react to rising prices. And how they react is that they are paying these price increases.

Companies are paying them because they know they can pass it on to their customers. Consumers are paying them, because they’re getting raises, and they’re still pouring in cash from all the pandemic money, from PPP loans, mortgage payments and rent payments they didn’t have to make, from gains in real estate and from cash reference last year, And from gains in stocks and cryptocurrencies, although those gains are beginning to dissipate.

Governments at all levels rely on huge amounts of cash in the era of the pandemic, and that money is spent, so wholesale prices go up and businesses pay for them, consumer prices go up, and people pay for them. And it happened suddenly, almost two years ago.

For many years, central banks have engaged in massive amounts of money printing and interest rate suppression. The Bank of Japan started this more than two decades ago, bought a large portion of government debt, suppressed interest rates to zero, and in recent years to below zero. It got away with it for years, and there was no consumer price inflation.

Then during the financial crisis, which began in late 2008, the US Federal Reserve began printing large amounts of money and suppressed short-term interest rates to zero, in order to save bondholders and bank shareholders, and inflation. Asset prices in general, to inflate stock prices, bond prices, and real estate prices. This also did not cause a large wave of consumer price inflation.

And when the ECB saw that neither the printing of money from the Bank of Japan, nor the printing of money from the Federal Reserve caused consumer price inflation, but only asset price inflation, it also jumped into the game and printed huge sums of money and pent-up interest rates for zero, then under Zero.

The central banks of smaller countries were doing it, and everyone in the developed world was doing it.

Then the pandemic came, and now all these central banks that were printing money and suppressing interest rates without causing consumer price inflation are going wild, thinking that these trillions of free money won’t cause inflation either, because they never did before. But this time the amounts were much larger, and they came very quickly.

Governments everywhere have spent the many trillions of borrowed money their central banks were making available through their bond purchases, and all this central bank monetary stimulus and government fiscal stimulus has swept the world, a large part of it into the US economy, and almost everyone here has gotten some of these Money, people, companies, state and local governments, and they all started spending that money.

This sudden wave of free money caused a historically high demand for goods, which created problems in the supply chain, which led to backlogs, waiting lists, people were so overwhelmed with money that they paid anything, and then the prices of goods went up . It started with used cars as prices skyrocketed, starting in late 2020.

That was when the dam broke. Inflation is beginning to flow into the United States.

Now the big push for inflation is no longer a commodity, it is no longer a commodity and energy, and gasoline prices have already fallen as with many commodities. Now the big push is coming from services.

Inflation has spread throughout the economy, and is deeply rooted in sectors that have little or no relationship to energy, commodities and supply chains.

So what we have here is that the dam that has curbed inflation for more than a decade of money printing and deficit spending has suddenly collapsed, and inflation has flooded the country and spread across it, and spread from sector to sector, and it’s huge, and more inflation has already started to unwind, the original catalysts, like energy chains Logistics, now services and other goods.

This dam that has broken cannot be reassembled, so that inflation or anything else evaporates.

We haven’t seen this kind of inflation in over 40 years. The previous dam that broke was during the oil embargo in the 1970s. This led to a long, massive influx of inflation, which was eventually brought under control, but in hindsight, by brutal monetary policies, as we can’t even imagine today, with 30-year fixed mortgage rates at 18%.

Today we grumble about the 6% mortgage rates. At the time, mortgage rates were three times higher than today’s 6% to control this inflation monster.

So no, this inflation is not going to go away on its own. It is self-reproductive. It has momentum, it moves from one part to another, and when prices stabilize or flip in one part, they rise in another. This is what I call the Whac A Mole inflation game.

The Fed has finally come to grips with this, too – more than a year later, with hindsight. But now it’s serious about this inflation.

And here’s the thing: With every meeting since last fall, the Fed has become excited and hawkish. All interest rate expectations — how often rates might rise, how big the hikes will be, and where the hikes might end — moved higher at each meeting.

So the Fed may now rise to 4% with its own short-term interest rates by the end of this year. It could rise to 4.5% by early next year.
[Update: at the FOMC meeting this week, a few days after this podcast aired, this was moved up to about 4.4% by the end of this year, and higher next year… read: Powell’s Whatever-it-Takes Moment].
We now believe that the Fed may then pause to see how they react to inflation. But inflation is getting worse in the heart of the economy, specifically in services, so the Fed may not stop at 4.5%, and basically all bets are off until we see some containment of this inflation in the heart of the economy.

The Fed is now also engaging in quantitative tightening, or QT, which means it reverses quantitative easing, which will reverse the effects of quantitative easing, which was the bubble of everything, as all assets rose together. This is now reversed.

The QT program ramped up at full speed in September. Last week, the Fed stopped buying mortgage-backed securities entirely. She let her mortgage-backed securities slip off the balance sheet. By getting away from the mortgage market, the Fed will no longer suppress mortgage rates, and they will go where the market thinks they should go, given inflation is over 8%. Mortgage rates have already more than doubled from 3% a year ago, to more than 6% now.

The more difficult and faster the actions of the Fed by raising interest rates and emptying its balance sheet, the faster inflation may decline. But the Fed has yet to take drastic action. It still only reduces the amount of fuel he pours on the blowing fire.

The maximum target range for the Federal Reserve for the federal funds rate is currently 2.5%. [update: as of Wednesday, it’s 3.25%]And with inflation over 8%, the Fed is still pouring massive amounts of fuel on the fire.

There is a good chance that it will raise its target by 75 basis points at its meeting this week [update: it did], which will raise the higher percentage to 3.25%. With CPI inflation over 8%, it will resident Huge amounts of fuel are poured into the fire.

Even if it goes up a full percentage point, with its highest range at 3.5%, then it will go up resident Huge amounts of fuel are poured into the fire of inflation.

Interest rates have to go up a lot to eliminate inflation. This includes long-term interest rates and mortgage rates.

It doesn’t help that government spending, and I mean at all levels of government, still stimulates the economy and fuels inflation. State and local governments are full of pandemic money, and they will spend it.

And the federal government is still pumping in money, including things like incentives for electric vehicles where demand is really hot, prices are already increasing, and there are really long waiting lists to get one, so the government is now throwing a lot of billions of dollars in stimulus money at the head of the auto sector. Electric already hot. This stuff is just crazy – to stimulate demand in an already sweltering sector with higher prices.

This happens everywhere. In other words, this is still a hugely stimulating economy, fiscal stimulus, as well as monetary stimulus. The inflation dam has broken, and new inflation is pouring into the economy.

To control this, a lot of action will be taken by the Federal Reserve. Governments do not contribute anything to the fight against inflation. exactly the contrary. They are lined up to stimulate inflation. All this on the shoulders of the Fed.

So this inflation isn’t going away any time soon. It has a good chance of going worse next year. And it’s going to take years to get this under control, years of high interest rates, years of asset prices dropping a lot.

But it also means years of much higher returns for bondholders and savers who buy those products in the future. Some Treasury yields are already 4%, like the one-year Treasury yield. Some one-year CDs are already up to 3.5%. Some savings accounts are around 2%. And they will all rise as we go forward. But it is still well below the inflation rate.

We’re looking at years of drastically lower home prices, and lower commercial property prices a lot. The entire asset bubble – the bubble of everything inflated by years of money printing and interest rate suppression – the bubble of everything will be re-priced, some of which have already been partially re-priced.

Cryptocurrencies are down 70% or so. The overall stock market is down 20%, according to the Wilshire 5000 Index as of Friday. The most speculative parts of the stock market are down 70%, 80%, 90% or more, like hundreds of stocks that have gone public via IPO or SPAC over the past two and a half years – my infamous exploding stock.

It has just started. We are only a few months into the Fed tightening. The Fed is still far from the curve. Inflation is now raging at the heart of the economy where it is difficult to dislodge. Gone are the many years of easy money, and they won’t be back anytime soon.

I think central banks are now learning a lesson how the combination of printing money and deficit spending did fine for many years, until the dam suddenly collapsed, and inflation swamped the economy, when no one expected it anymore, leading to years of severe chaos. The process to bring this back under control.

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