Triple Shock for the Fed

Both too hot and too cold, Goldilocks...

INFLATION in the US hit a 40-year high of 7.5% in January, writes Jim Rickards at The Daily Reckoning.

That comes on top of another 40-year high of 7.0% the month before. Jay Powell's vision of "transitory" inflation is now in shreds.

It's clear that the high inflation we are experiencing now is partly due to the 2021 package of $1.9 trillion in giveaways. If the economy is running close to short-term capacity in terms of labor markets and manufacturing ability and you throw $1.9 trillion at it, inflation is the predictable result.

The 7.5% inflation rate is an overall average calculated by the government based on about 29 main categories of goods, and thousands of individual items inside those categories.

When you look past the average to particular goods, what you see is that the prices of things people buy most often such as meat, eggs, bread, poultry and gasoline are going up at an even faster rate, sometimes 10%, 20% or even 40% (these price hikes are offset by lower prices for tuition, health care and air travel that people consume far less frequently).

This kind of inflation poses an acute dilemma for the Fed. On the one hand, the Fed must tighten monetary policy in order to snuff out inflation. On the other hand, if the Fed tightens more than slightly, there's a danger they will throw the economy into a recession. Unfortunately, a recession is exactly what will be required to beat this kind of inflation.

The Fed is trying to finesse the situation with a Goldilocks approach of not too tight, not too loose, but just right. They will fail at this. The stock market gets a vote.

As the Fed tightens and the economy slows, the market will begin a steep decline in anticipation of a recession. The Fed doesn't care much about the decline, but they do care if the decline becomes "disorderly".

That's hard to define, but drops of 3% or more for three-five days in a week over multiple weeks (similar to what happened in March 2020) definitely meets the definition. That's coming.

At that point, the Fed will throw in the towel and stop cutting rates. Then the inflation will return. So here are your options (and the Fed's): more inflation, a stock market crash or recession.

Investors are certain to have at least one, maybe two, of these outcomes in the year ahead. The odds certainly increase with the ongoing supply chain disruptions, even if the trucker protests end tomorrow.

But given the Fed's consistent incompetence, we may get all three: more inflation, a stock market crash and recession.