Federal Reserve Watch: Which Way Inflation

The Labor Department figures for August inflation:

Year-over-year, consumer prices rose by 3.7 percent.

Furthermore, core inflation rose 4.3 percent.

The Federal Reserve prefers another measure of consumer prices, one put out by the Commerce Department.

By this measure, core inflation for August is expected to be up by 3.8 percent from a year earlier.

So, where is inflation heading?

Is inflation going to continue to move on down in September and beyond, moving toward the Fed's target of 2.0 percent?

Or, will inflation resist the year-and-one-half efforts the Fed has been making to bring the inflation rate down to its target?

Justin Lahart writes in the Wall Street Journal that "Betting on Falling Inflation is Risky."

"It might make sense for investors to bet that inflation will cool enough to keep the Fed at bay. That doesn't mean they should bet the house on it."

Colby Smith writes in the Financial Times

"The risks do appear to be skewed to the upside...a tight labor market and persistently strong consumer spending would continue to put pressures under prices across the economy."

The battle is not won.

And, the Fed fights on.

Federal Reserve Action

Securities held outright by the Federal Reserve dropped another $6.0 billion in the banking week ending September 13, 2023.

For the month of September, the Fed's securities portfolio has declined by $24.4 billion.

Since March 16, 2020, at the start of the Fed's quantitative tightening, the securities portfolio has been reduced by slightly more than $1.0 trillion. The exact number is $1,006.8 billion.

Overall, Reserve Balances with Federal Reserve banks, a proxy for "excess reserves" in the commercial banking system have fallen by $582.9 billion.

One needs to point out, however, that the commercial banking system still carries a massive amount of cash on its balance sheets.

The latest numbers for the commercial banking system show that commercial banks have approximately $3.3 trillion in "cash' on their balance sheets.

This is not trivial.

What this signals to me is that the financial system, as a whole, has a "huge" amount of liquidity.

And, this huge amount of liquidity helps to explain why the economy continues to be as robust as it has been and why the stock market continues to bounce around, and why inflation continues to remain sticky.

In a real sense, the Federal Reserve still has a lot of work ahead of it.

Note One Change

One important change needs to be mentioned.

Throughout the whole time that the Federal Reserve has been reducing the size of its securities portfolio, Fed officials have used the "tool" Reverse Repurchase Agreements to help manage the money markets and keep the tightening effort on a smooth path.

In the last banking week, Reverse Repurchase Agreements dropped below the level they were at when the Federal Reserve started out on in quantitative tightening path.

On Wednesday, September 13, 2023, Reverse Repurchase Agreements fell to $1,835.6 billion. On Wednesday, March 16, 2022, Reverse Repurchase Agreements totaled $1,864.6 billion.

The following chart shows just how much the Federal Reserve used this "tool" to manage the markets during this time of quantitative tightening.

Since June 2023, the Federal Reserve seems to have needed Reverse Repos less and less to manage the markets and keep things "under control."

The Future

Where does the Federal Reserve go from here?

Well, Chairman Jay Powell continues to talk about how Federal Reserve officials need to keep focusing on what is happening in the markets.

Will the Fed need to continue to raise its policy rate of interest?

Maybe...maybe not.

How will the impacts of the union strike on the automobile companies impact the economy?

Keep watching.

There are lots and lots of things that might go astray.

As I have discussed, over and over again, I see the world right now as one that is subject to radical uncertainty.

In looking at the future, we can't assign probabilities to even the possible future events that might happen, let alone the unknown unknowns that we can't identify.

Who forecasted the possibility that Russia would go to war with Ukraine, even a week or so before the invasion began?

This is the environment that leads Mr. Powell to the position he has taken as the leader of the Federal Reserve.

We need to keep a close watch on things...and keep watching...and keep watching.

The European Central Bank just raised its policy rate to a new, historic high.

Inflation is still a concern there.

But, the European Union seems to be on the verge of a recession, if it is not already in one. Germany, the strong center of European economic strength, seems to many, to be in a recession, now.

And, what about England? And, what about Canada?

The U.S. Dollar

And, amid all this turmoil, the value of the U.S. dollar has strengthened.

This morning, Friday morning, September 15, 2023, one could buy one Euro for about $1.0650. And, one could buy one British pound for about $1.2400.

The world seems to see America as the place to put its money.

So, we have even more money coming into the U.S. economy!

This raises another question...how should the Fed respond to the strengthening U.S. dollar?

And, finally, how should the investor respond to all these "facts"?

To me, the overriding fact right now is the radical uncertainty that exists in the world.

To me, caution is the word of the day.

Like Mr. Powell, we need to be cautious and we need to watch.