Inflationary data suggests the Fed is now stuck between a rock and a hard place

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The government released the inflationary report for September today vis-à-vis the CPI (Consumer Price Index), which showed that inflation continues to increase. In July of this year, the consumer price index reached an apex of 5.4% and then decreased to 5.3% in August. Today’s report shows that inflationary pressure is now back to 5.4% year over year. Estimates by economists polled by Dow Jones were forecasting that this rate would increase only by 0.3% keeping the year-over-year rate at 5.3%.

The current inflationary pressures are once again at a 30-year high. More importantly it is well above the target of the Federal Reserve. The dual mandate of the Federal Reserve is to maintain maximum employment and a 2% inflationary target rate. Recent rates have been more than double of the Fed mandate. The U.S. Bureau of Labor Statistics report revealed that consumer prices rose 0.4% in September which took the year-over-year gain back to 5.4%.

However, the Federal Reserve adjusted its dual mandate to focus upon maximum employment and let inflation run hotter than their 2% target. The thought process by the Federal Reserve was that much of the current inflationary pressures are transitory in nature and will subside in a relatively short time.

According to MarketWatch, “Stronger-than-expected U.S. inflation data for September has the bond market now considering the risk that the Federal Reserve may end up being forced to tighten interest rates into a stagnating economy with persistently higher price rises.”

The Federal Reserve is most likely correct in predicting that certain components of our goods and services have seen inflationary pressures that are transitory due to supply and labor shortages. But the real issue is the rising costs of food and energy. Many analysts, including myself believe that the cost of energy and food could continue to rise and create inflation that is systemic and prolonged. Gasoline prices rose 1.2% for the month which resulted in an annual increase of 42.1%. In September, food prices also had a dramatic gain increasing by 1.2% and increased 12.6% year-over-year.

Concern about rising inflation and the Federal Reserve’s persistence that it is transitory is being questioned by the International Monetary Fund. According to an article in CNBC, “On Tuesday, the International Monetary Fund warned that the Fed and its global peers should be preparing contingency plans should inflation prove persistent. That would mean raising interest rates sooner than expected to control the price gains.”

There are also members of the Federal Reserve who are not convinced that current inflationary pressures are transitory. Yesterday, when Atlanta Fed president Ralph Bostic commented on the factors that have created the inflationary pressures, higher inflation “will not be brief.” St. Louis Fed President James Bullard also commented on his fears that inflationary pressures will continue telling CNBC that he believes the Federal Reserve should be more aggressive in withdrawing its economic support, “reducing their monthly bond purchases.” If inflation proves to be a problem, he also believes that that would require an adjustment to lift off the first set of rate hikes beginning next year.

Gold prices benefited greatly from today’s news with the most active December 2021 futures contract gaining over $34 and currently is fixed well above $1790 per ounce.

The Federal Reserve’s assumption that recent upticks in inflationary pressure are transitory is a dangerous assumption if they are incorrect. They have painted themselves into a corner with nowhere to go that would not cause economic pain should they begin to raise interest rates sooner than they had anticipated. While it is clear that the economy in the United States is recovering, the pace of this recovery is much slower than they had anticipated. This means that being forced by inflationary pressures to begin to unwind their extremely accommodative monetary policy too early would severely lengthen the time needed for a full economic recovery.

Wishing you, as always, good trading and good health,

Gary S. Wagner - Executive Producer