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The Fed just edged a step closer to recognizing a a major policy misstep

Aug 26, 2024, 22:32 IST
AP ImagesFederal Reserve Chair Janet Yellen tours Daley College in Chicago, Monday, March, 31, 2014. The Federal Reserve is embarking on an annual summer ritual: Downgrading its overly optimistic forecasts for economic growth and, potentially, preparing for a pause in interest rate increases.

Wall Street rallied after Fed Chairwoman Janet Yellen's testimony to Congress this week as she seemed to open the door for such a pause, by acknowledging that a recent decline in inflation further below the central bank's 2% target may not, in fact, be as fleeting as policymakers had hoped.

Yellen, as she has in other statements recently, told lawmakers that she expects low inflation to be transitory. "Temporary factors appear to be at work. It's premature to reach the judgment that we're not on the path to 2% inflation over the next couple of years," Yellen said.

But, and this was enough for salivating bulls looking for hints that rate hikes could slow down or pause, "As we indicate in our statement, it's something we're watching very closely, considering risks around the inflation outlook."

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The latest figures are clearly heading in the wrong direction. Consumer prices held flat in June despite expectations for a 0.1% increase and the annual rate, which the Fed watches closely, registered just 1.6%.

The Fed's preferred measure of inflation, the personal consumption expenditures index, has also been slipping.

Andy Kiersz/Business InsiderThe Fed's preferred measure of inflation has been slipping.Fed policymakers "have a pause built into their baseline estimates and it seems the inflation data present a reason to exercise that pause option in September," according to Julia Coronado, president and founder of MacroPolicy Perspectives.

"Caution on the part of consumers comes despite a solid job market and booming equity markets and is feeding into core inflation through price wars on cell phone service, airfares, cars, clothing," she told Business Insider.

"If this continues the Fed won't be able to move much further on rates, but they can also take comfort that what may look like an asset bubble isn't fooling firms, banks, or consumers into spending with reckless abandon."

As if on cue, not one but two regional Fed banks have just downgraded their growth estimates. The New York Fed predicted 1.9% growth in the second quarter of 2017:

Federal Reserve Bank of New York

While the Atlanta Fed's GDPNow model slipped to a prediction of 2.4% growth:

Federal Reserve Bank of Atlanta

"Coupled with ongoing soft inflation data, continued weakness on the consumer side suggests the Fed's conviction for a second-quarter rebound was but a figment of monetary policy imagination," said Lindsey Piegza, chief economist at Stifel Nicolaus.

The Fed has frequently been overly optimistic about its predictions for rate hikes in the post-recession era. This rather stunning chart from Deutsche Bank's Torsten Slok is rather instructive:

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Deutsche Bank

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