1. The Fed will have a difficult time controlling US inflation
This widespread belief is a relatively new one. Prior to 2022, most economists would have said that the US Federal Reserve’s (Fed)’s biggest challenge was guarding against disinflation. These days, however, many doubt that the Fed will be able to bring inflation down to its 2% target anytime in the near future.
I agree with the long-term structural arguments for higher inflation resulting from deglobalization, but contrary to most observers, I believe the real problem over the next year could actually be that the Fed misses its inflation target to the downside. Certainly, the Treasury Inflation-Protected Securities (TIPS) market embraces this possibility, with forward-inflation expectations recently below the Fed’s 2% long-term target (as measured by the Personal Consumption Expenditures Price Index, the Fed’s preferred inflation gauge).
Why the disconnect between market consensus and my own view? Bank lending, which is the most high-powered form of money (and thus most closely related to money velocity), is likely to slow amid today’s tighter credit conditions following the turmoil in the US banking industry (Figure 1). If that proves correct, why wouldn’t we expect inflation to cool and even surprise meaningfully to the downside?
Monthly Market Review — August 2024
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Brett Hinds
Jameson Dunn