Forward Restraint
March 20, 2024
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–What’s the problem? The problem is that service inflation is not coming down; we think goods inflation is probably under control. The three elements of financial conditions that have become easier are 1) equity prices are frothy 2) credit spreads are tight 3) long rates are relatively low. Service inflation would likely decelerate and employment, which is already edging slowly higher, would likely respond in our favor if we could reverse the stimulative effects of the loosest aspects of financial conditions.
–We already are debating the end to QE for technical reasons. There is a risk that both equities and bonds might embrace reduced QE as a reason to run higher. However, the already restrictive stance in the current FF target likely warrants some easing, as was forecast in the last SEP. The deleterious effects of a weaker yuan and recession in Europe might be accentuated by a signal that we no longer intend to ease in 2024. The lower end of the income population is already straining under high short-term funding rates.
–How can we officially signal a monetary posture to support our goals? Rather than flip-flop on our near term FF projection, let’s move the 2025 and 2026 projections higher. That will counteract QE trimming and will discount forward cash flows, taking stocks lower and bond yields higher.
In December, the FF projection went from 5.1 to 4.6 in 2024, 3.9 to 3.6 in 2025, and remained steady at 2.9 in 2026. I would recommend leaving 2024 at 4.6, but push 2025 back up to 3.9 and notch 2026 up to 3.1. The front end of the SOFR curve is already fairly priced with the current 2024 projection, but forward rates would likely achieve tighter financial conditions which will support deceleration in Service inflation.
