Ethan Harris is anthing but convinced that that inflation is under control and heading steadily toward its 2% target. In fact, as we take a look at the minutes of the last Federal Reserve’s May meeting, where “almost all” members of the policy making Federal Open Market Committee noted the risk that inflation could prove more persistent than expected, he says there are important signals that not only is it not time to declare victory, it is time to remain vigilant.
This former head of Global Economic Research at Bank of America, who early in his career was as the head of the Domestic Reseach Division at the Federal Reserve Bank of New York, is alarmed at the jump in key measures of inflation expectations in the University of Michigan Consumer Sentiment Survey, which he notes is “the longest running survey of its kind.” Importantly “it is running at 1980’s type levels…those are really ugly numbers…consistent with press reports around people worried about inflation.”
The May Fed minutes also showed that the Fed Board’s staff economist see more than 50% odds the U.S. will fall into recession this year, as the FOMC’s own baseline forecast is that it will slow considerably but continue to grow a 1.4% rate. Ethan says the hard economic data show “the economy still looks okay.” His worry is on the inflation side where the Fed itself is expressing the view that inflation has gotten a little sticky above target so its job isn’t quite done.
”Even if you ignore the trade war, they still have some work to do,” he says. “And I think the thing that strikes me, and puts me more on the hawish side of both inflation and the Fed, is the preconditions coming into this period.
”We just went through a serious inflation acceleration. That inflation acceleration was big enough to impact the presidential , and it’s even today affecting the favorability ratings of the President,” adds. “So it’s clearly a real issue out there.”
As for the odds of Congress taking steps that will start reducing the budget deficit and reassuring bond investors who are worried that foreign investors are growing more wary over holding U.S. Treasury bonds, Ethan is worried that an ongoing bipartisan - both Republicans and Democrats - reluctance to take the necessary steps is going to stand in the way yet again.
So dive in and hear what Ethan has to say. It may not reassure you but it will certainly make you think.
Fed meeting ‘minutes’ 00:02:08:20
There was no big surprise here. I mean, the Fed is like glued to its seat right now and they are confused like the rest of us, that the risks -<on both sides>- of their forecasts are massive. On the one hand, we could have a serious inflation acceleration. Certainly some of the measures of inflation expectations are looking ugly. On the other hand, their own Doom board staff said there is a pretty good chance of an outright recession. So those two things are being weighed by the Fed. I think what they're saying makes a lot of sense. We think they're not going to jump until they know a little better about which of these shocks is going to dominate.
The Fed is content to wait 00:03:45:17
The hard data right now hasn't done much. And that's where the Fed gets the idea that they can wait and watch. And that's true for both the growth numbers and the inflation numbers. The economy still looks okay. On the inflation side, they make it clear they recognize they haven't quite hit their target. You know, inflation's got a little sticky above target and so the job isn't quite done.
The Fed seems to have lost focus on what matters most 00:04:10:03
The thing that that strikes me and puts me on the more hawkish side of the debate on inflation and the Fed’s preconditions coming into this period. We just went through a serious inflation acceleration. That inflation acceleration was big enough to impact the presidential election, and it's even today affecting the favorability ratings of the president. So it's clearly a real issue out there. It's not something that economists dreamed up. And if you look at some of the survey measures, they look quite high. And so if I'm the Fed, I'm worried that that side of the mandate is dangerously close to that, that an anchoring moment on anchoring is like a four letter word in central bank lexicon. It's like the worst thing for inflation, targeting central bank. They have to keep a close eye on that and there's a real risk going forward. So I would if I'm the Fed, I'm a more worried about that right now than I am about a recession. Well, and in fact, in the minutes, quote, almost all unquote, participants, in other words, a Fed Reserve official said open market committee members noted the risk of inflation could prove more persistent than expected.
Premature Fed jubilation 00:05:58:09
Well, I think there was some premature kind of breaking out the champagne like a year ago. Look at the trajectories. Back to two. And what's happened is the data just isn't cooperating. We've kind of settled in to say two and a half percent for the Fed's official measure of inflation. Typically, deflator. I mean, as you said, the CPI is running higher.
Chuck ‘the core’ get ‘The trim’ 00:06:23:11
I'm on a little bit of a religious campaign to get people to focus on the right measure of core inflation. So if you look at the history of inflation, there are these temporary factors like food and energy shocks that create weird movements in inflation. And so the tradition which holds today is to take them out, take food and energy out. I don't like that. I think that we should be focused on what the Fed based measure called the trim mean. It takes out all the weird stuff at both ends. And the economist doesn't decide. The data decides if an indicator is super volatile on either high or low end, it takes them out. If you look at measures like that that focus on the kind of the center of the distribution and the kind of underlying trend in inflation, they're all consistently stuck in the 2 to 3% range.
The University of Mich expectation survey matters 00:07:21:19
They just don't want to go down. And so the starting point, given this new, more chaotic economic outlook, is no job, not finished. There's still a little bit of work to do. Well, you know, if you look at a chart of the University of Michigan survey, which has been done for more than 50 years, when you look at their survey of inflation expectations, you can see that over the last year or two, that long term inflation outlook, not the short term one. Some people like the short term, other people say, but that the longer term inflation outlook is more clearly showing not what gasoline prices are doing up or down, which affects the near term. Looks frequently a lot. But more about this kind of big picture view of where inflation is going. I know you watched that survey very closely and you put a lot of weight on it.
Survey authentically reflects what people think 00:08:17:23
Why? Well, so it's the longest running survey of its kind. And the road the track record is pretty good, you know. It shows that, for example, in the 1970s, we had obviously crazy high inflation. And the Michigan survey got sticky high. We came out of that inflation and people didn't really believe it. And they kept saying, we think inflation over the next five years or so is going to be high. So I take it quite seriously. You know, today it's running at 1980s type levels. It's really those are really ugly numbers. And the final thing I would say about the Michigan measure is it does seem consistent with what we all see on a day to day basis, which is tons of press reports around people worried about inflation.
Tariffs come on line in a fragile situation 00:09:39:07
But, you know, there are cracks in the dam here. And I, I that's why I think the Fed is very worried that, you know, tariffs could be the final no final blow that drives inflation expectations higher. It's not that they're the only things, but they're hitting at a time when there's already concerns about inflation.
The ‘70s: Lost Fed Cred and bond market vigilantes- 00:10:57:
In the seventies, people the Fed basically lost its credibility in terms of it as an inflation fighter. You had three big rounds of inflation each time the Fed would lower inflation but not get it back to normal levels. And then you had a long period where people expected high inflation and you had, as a result, high bond yields for a long period of time. The bond vigilantes got their got their revenge during that period and they had to borrow at very high rates. So I would I think that Ben is right. I do think that it's hard as a Fed official to even even hint at an anchoring because it's it's such a like I said, for a letter word. I sometimes describe it as a sea anchor.
The risk to inflation from tariffs 00:13:13:03
I don't think we can get reciprocal tariffs, though. So there will be some kind of gradual pass through and gradual increase in tariffs. But more important than that is what we just talked about, the expectations story, that once you convince people that inflation is here to stay, it starts to drive their wage demands and their price decisions for companies. And that's what creates this persistence in above target inflation. That's what happened in the 1980s. So that's what we need to watch. Expectations, it's a it's kind of a wonky subject for the average investor, but it's so important to economics. Hey, well, many people cited as a reason why one of the big things working against the Democrats in the last election and against President Biden and something that is hurting Trump's rankings now.
The trade debate sinks in 00:15:07:12
Yeah, I think that the problem with the whole trade debate is it's so black and white. Either you think trade is a disaster or you think that it's it's a natural result of market forces, but it's a combination. I think that the the mistake that the US made and I think it took a while for a lot of economists, including myself, to figure this out, was that you couldn't allow China to just kind of flood your market with product without creating local disasters in your manufacturing sector.
China cheated on trade 00:15:42:11
So China did cheat on trade. They subsidized and they you know, they have a national policy of creating champion industries right now. They're doing it again with EVs and stuff like that. And it's it that that is unfair trade and that should be pushed back hard again. So I've never questioned the idea of, you know, going to quote unquote, war with China. But for most of the world, including some of our closest trading partners like the EU with Canada and Mexico, there is not unfair trade. It is true that we have deficits with them. But we need to remember that the trade deficit isn't just because of unfair trade rules. It's because as a nation, we've got this kind of addiction to spending, right?
Fiscal issues in Trade 00:16:33:03
If you look at the what the imbalances in the US economy. Why are we running 6% of GDP budget deficit right now? That has to be funded by a huge inflow of foreign capital. When that capital comes in to the US, it tends to create a stronger dollar and that hurts our trade. We are consumers sector. Consumers have relatively low savings rates in the United States compared to other countries.
Bipartisan fiscal excess 00:19:52:18
Right. So which I think would be great if the economy so strong everybody had to pay them, you know, could benefit from tax cuts. But that's kind of a specific thing. What what do you think is going to happen with that? It looks like this is another year where budget deficit just gets bigger, bond yields maybe to go up. So the pattern we're seeing is that when Republicans are in power, we get tax big tax cuts, small spending cuts. When Democrats are in power, you get big spending increases and small tax increases and the deficit goes up in both cases. So that's how we got to where we are now. And it's it's history is repeating itself with the big, beautiful bill.
Politicizing the Fed 00:22:49:09
You have talk about politicizing the Fed. That's a new thing. The recent presidents have left the Fed completely alone. That's not good for the bond market. To say that you're going to put in a politically compromise Fed chair, even if it's just replacing Powell when his term is up, and then you have the trade war going on and here's something I think you may not have heard from others, but I think is important.
ETHAN HARRIS
Ethan Harris is a closely followed private economist, who posts his “Ethan on the Economy” regularly on Linked In.
Prior to this Ethan Harris, he was the head of global economics research at Bank of America Securities. In this role, he was responsible for the US growth, inflation, and monetary policy call.
He also coordinated the global economics forecast and publication and managed the developed markets economics team. Harris regularly ranked highly in investor polls and forecast surveys.
Before coming to BofA, Harris was the chief US economist at Lehman Brothers. He also worked as an economist at Barclays and JP Morgan and spent nine years at the Federal Reserve Bank of New York, where he was assistant to the president and head of the Domestic Research Division.
Harris earned a bachelor's degree in economics from Clark University and a PhD in economics from Columbia University, where he was a University Fellow. Harris is the author of Ben Bernanke's Fed: The Federal Reserve after Greenspan.
Share this post