“A number of participants” at the April meeting of the US Federal Open Market Committee “suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases,” according to meeting minutes released May 19.
That means the Fed hasn’t agreed to talk about the inflation problem, but it might agree to talk about it in the future, which isn’t the same as doing something about it. But the threat of such a discussion was enough on Wednesday to push up the yields on inflation-indexed Treasury notes and sink the stock market.
The latest reading from the Manheim used vehicles index, the industry-standard monitor of wholesale used car prices, shows that prices continued to head straight up during May. Used vehicle prices are up more than 50% year to date (that’s a compounded rate of about 200% a year), compared with a paltry 20% rise in the Consumer Price Index for used vehicles.
We’ve seen minor discrepancies between the Manheim Index and the CPI measure in the past, but the divergence of the past several months is utterly without precedent.
The trouble is that automakers can’t make cars without computer chips, mainly microcontrollers, and the chipmakers can’t make enough of them. US automakers assembled just 8.67 million vehicles at an annual rate in April, down from 10.5 million before the COVID-19 lockdown.
Industry experts tell me that the chip shortage in the auto sector will persist through at least 2023. Demand for autos is inelastic in the US so used vehicles are subject to a bidding war. We haven’t seen half the inflation in used car prices that is already in the pipeline.
The US government has two different measures of rent inflation – the Census Bureau’s index of asking rents, and the Consumer Price Index rent component. The Census number in the past has risen slightly faster than the CPI series, but they followed the same trajectory—until the past twelve months, when the Census number showed a rise of nearly 20% while the Consumer Price Index rent component rose just 1.7%.
The Fed’s credibility is pretty threadbare – closer to bare naked, in fact, like the Emperor with his new, invisible suit of clothes. The trouble isn’t that the emperor has no clothes, but that the emperor has no tailors: The entire Board of Governors of the Federal Reserve and the heads of the regional Federal Reserve Banks have staked their reputations on the premise that the present inflation is transitory.
They are hesitant to tighten monetary policy, with good reason. They are buying $120 billion a month of Treasury debt, and the commercial banks are buying more than half that amount. They have to, because the Treasury has to finance a debt equal to an astonishing 15% of GDP.
If investors think the Fed will raise rates, they will wait to buy Treasury debt until after the dust settles. Short-term rates, moreover, rise faster than long rates when the Fed tightens, which will make Treasuries less desirable as a bank asset. Commercial banks bought almost $1 trillion of Treasury debt during the past year, and that source of financing also will dry up.
The market will have a lot of days like Wednesday during the coming year, as investors anticipate the end of easy money. We are a while away from a mortal leap on the part of the Fed into tighter money. But the relentless buildup of price pressures makes it inevitable. Be afraid – be very afraid.