Taps Coogan – July 20th, 2021

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According to the Fed’s latest forecasts, PCE inflation is going to average 3.4% for the entire year. CPI inflation is currently running at 5.4%. According to Shadow Stats, CPI calculated using the Bureau of Labor’s methodology prior to 1980 is running at over 12%. Notably, the pre-1980 methodology included owner-occupied housing costs, which the current version omits.

Despite inflation far in excess of the Fed’s now-abandoned 2% target, the Fed is running QE at a record pace of $120 billion-a-month.

How have interest rates responded?

They’ve dropped to near record lows.

No, that’s not because investors are expecting inflation to drop low enough to make bond holders whole at current yields. That view is not consistent with negative TIPS yields all the way out to 30 years.

So, why is this happening?

Quantitative easing is a financial-asset-for-cash swap. The Fed adds money into the financial system while removing yielding assets like treasury bonds and mortgage backed securities. More money chasing fewer yielding assets drives prices up and interest rates down. Inflation, if it has any bearing on that dynamic, only increases the incentive for capital to move out of cash and into anything with a yield, even if that yield is less than inflation.

The only limit to the Fed’s ability to push financial asset prices up and yields down is their willingness to do so.

Inflation only really matters to financial assets to the extent to which it matters to the Fed.

In other words, the only limit on monetary policy is the Fed’s own foolishness.

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