Monetary policy operates with a lag
July 18, 2022
–It takes six months to a year for monetary policy to take effect. The Fed’s first rate hike was in March, just four months ago. How do you know, as a central banker, if you’ve done too much? It’s probably when the yield curve has inverted to new lows. 2/10 ended the week at -21 bps, just under the lows made in 2006 and about 30 bps away from the 2000 low of -56. 5/30 is +3.5, off the low made last month (-17), but the current level is still right around levels from 2006. The red/gold euro$ pack spread ended the week around -23, well off the low made in March of -87, but still significantly below the bottom in 2006 (+10) and 2018 (-6). The curve is telling the Fed that conditions are tight, perhaps the reason that Waller and Bostic signaled 75 bps at next week’s meeting, even as scorching CPI (9.1) and PPI (11.3) made the case for 100.
–The ten-yr inflation breakeven ended the week at 237 bps. That’s still above the highs set in 2018 of 219 bps, but substantially off the year’s high of 303. U of Mich latest survey for 5-10 year inflation expectations fell to 2.8 from last of 3.1. August FF traded a low of 9746.5 last week post-PPI, only 4.5 bps away from what would be 100 bp hike of 9742.0. This morning they trade 9762.5, just 4.5 bps away from the 75 bp level of 9767.0.
–How, as a central banker, do you know if you haven’t done enough? One clue might be when equity markets and other asset values stabilize and rally. That’s a signal of financial accommodation. If asset values have contributed to an inflationary mindset, they must be deflated to change the psychology. JPM’s announced pause in share buybacks is likely an important cue, but the core message needs more emphasis.
–ECB and BOJ this week.
