Forward Guidance & Demand Destruction
Macro Perspectives
Yesterday we looked at the Fed's recent economic and policy projections (click here).
In these projections, the Fed painted a pretty gloomy picture:
ultra-low growth,
rising unemployment,
and what would be a stifling increase in interest rates through the end of the year.
If they were to follow through on this outlook, they would bury the economy in a deep recession.
Keep in mind that these projections are part of the Fed's "forward guidance" strategy. And "forward guidance" is an explicit tool at the Fed's disposal (just like interest rate setting) intended to manipulate behavior.
What behavior do they want to manipulate?
Hiring.
Spending.
Investing.
Confidence.
Mostly, they want all of this to manipulate the "expectations" of where inflation is going. The Fed is far more concerned about inflation expectations than it is about inflation. If they lose control of expectations, people start pulling forward purchases in anticipation of higher prices, creating a self-fulfilling upward spiral in prices.
On that note, they are winning. This next chart is their favored gauge for measuring inflation expectations.
As you can see, there was a spike in inflation expectations early this year - the spike peaked in April. This happened as the Fed was making the first rate hike (moving away from zero rates).
The Fed's fear at that time was a continuation of that spike (both the rate of change and the rising level of expectations). But as you can see to the far right, inflation expectations have since been very tame—and that's tame relative to history, despite the forty-year high in inflation.
Then Powell said as much the other day: "Despite elevated inflation, longer-term inflation expectations appear to remain well anchored."
So the Fed is winning, in that they've successfully killed the animal spirits in the economy;
We can see it in the deteriorating economic data.
We can see it in the lower trending price data.
I suspect Wednesday’s use of "forward guidance" was intended to secure a little more demand destruction (a little more power in the punch).
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