- Inflation remains at high level even if price increases slow down
- Jackson Hole may address questions on quantitative tightening
- Looming recession complicates QT in the U.K. and Europe
U.S. consumers are getting a painful lesson in grammar—the difference between higher and high. Inflation was not higher in July, according to the consumer price index (CPI), but it still remains very high.
President Joseph Biden presumably knows that a 0% increase in prices month-on-month does not mean that inflation has gone to 0, when in fact the CPI was still 8.5% higher in July than a year ago. He may have felt that it was politically expedient ahead of the midterm elections to seize on what he could, but his remarks don’t strengthen his credibility.
Likewise, it doesn’t help to call legislation for tax and spending increases an Inflation Reduction Act when no one believes it will significantly reduce inflation and certainly not in the short term. The Tax Foundation has calculated that it could actually increase inflation by constraining growth.
Nonetheless, the CPI news helped maintain a stock market rally, though investors must now ponder how the Federal Reserve will react. Analysts will be scrutinizing the minutes from the July 26-27 meeting when they are released this week for clues as to whether policymakers will stick with a large hike of 75 basis points, or shift down to a 50-bp hike.
Another big jump in hiring in August, following the huge gain in July, could force the Federal Open Market Committee to go for a higher rate hike in order to subdue demand. August CPI will also be released before the September 20-21 meeting of the FOMC.
The absence of so-called forward guidance adds to the uncertainty as Fed Chairman Jerome Powell has abandoned the practice introduced with the financial crisis of reassuring investors about Fed intentions going forward.
Along with the July minutes this week, the other big date for divining Fed intentions will be the Jackson Hole symposium August 25-27. There is growing speculation that Powell will talk about Fed plans for trimming its balance sheet as it limits reinvestment of maturing bonds in its portfolio.
The Fed plans to run off $95 billion a month from its nearly $9 trillion balance sheet after ramping up to that amount by September. Depending on how that goes, the Fed could at some point announce outright sales of bonds.
The chances of recession—indicated by the inversion of shorter-term Treasuries yielding more than longer-term debt—complicates the picture, especially since no one really knows what the impact of this “quantitative tightening” will be in a market where liquidity is already thin.
The Bank of England plans to start selling off £40 billion of its holding of government bonds, probably in September, at a rate of £10 billion a quarter, and deputy governor Dave Ramsden last week said the central bank would not stop selling the gilts even if a recession forces it to reverse its rate hikes.
The European Central Bank has a more difficult course to navigate, as the war in Ukraine and Russian shenanigans with the supply of natural gas have increased the likelihood of a recession in the eurozone.
The ECB has halted its pandemic emergency purchases but has shifted its reinvestments of the maturing government bonds acquired in the program from core countries like France and Germany to peripheral countries threatened by the central bank’s rate increases.
The ECB bought €17 billion in Italian, Spanish, and Greek bonds in June and July, while letting its holdings of German, French, and Dutch debt fall by €18 billion, according to calculations by the Financial Times.
There could be more of this asymmetric quantitative tightening as the ECB has introduced a Transmission Protection Instrument to mitigate any growth in yield spreads by purchasing government bonds of vulnerable countries under certain conditions.