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February CPI 6.0% and Core Inflation 5.5%

February CPI 6.0% and Core Inflation 5.5%

March 15, 2023314 view(s)

 The Bureau of Labor and Statistics announced that February CPI came down to 6.0%, and Core Inflation was at 5.5%. The data aligned with market projections, but inflation remains stubbornly high. The CPI increased 0.4% from last month and is up 6% from a year ago. Core inflation raised  0.5% from January.


85% of the market expects a 25-basis point interest rate hike at the March 22 FOMC meeting. Last week, 40% of the market expected a 50-basis point hike after Fed Chairman Powell testified before Congress that rates would need to go higher. After the collapse of SVB and Sovereign Bank, no market makers are predicting a 50-basis point hike. Goldman Sachs is one of the only market prognosticators indicating a pause. “In light of the stress in the banking system, we no longer expect the FOMC to deliver a rate hike at its next meeting on March 22,” Goldman economist Jan Hatzius said in a Sunday note.

Over the last several months, the market has looked for any hope of a pivot. The market sees the rapidly developing banking crisis as the reason for the Fed to change course. I am the extreme contrarian because I think the banking crisis is what the Fed wants to happen. Interest rates will continue rising higher than the market believes. 

Since Chairman Powell’s Jackson Hole speech, he repeatedly stated that economic pain is necessary to quell inflation. The Fed is determined to “destroy aggregate demand.” Aggregate demand is a politically obtuse way of saying purchasing power. Purchasing power is destroyed by making access to money more expensive (raising interest rates) and taking away sources of income (raising the unemployment rates and destroying the jobs market). However, the banking crisis has created an almost risk-free playground for the Federal Reserve to do whatever it wants.

In response to the crisis, the Treasury, Federal Reserve, and FDIC released a joint statement to strengthen confidence in the banking system. The Federal Reserve Board announced it would make additional funds available to depository institutions. The Fed will make funds available by creating a new Bank Term Funding Program (BTFP). One-year loans will be available to banks, savings associations, credit unions, and eligible depository institutions. The financial institutions must collateralize their debt with Treasuries, agency debt, and mortgage-backed securities. The BTFP's purpose is to eliminate an institution's need to sell those securities like SVB needed to do quickly. Here’s the kicker. Don’t miss this. The bonds will be sold at par. 

They call it a loan program, but let's call a spade a spade. It is quantitative easing. The Fed is flooding the banks with liquidity in exchange for securities. Since they trade at par, the Fed has no exposure risk to interest rate hikes on the collateralized securities. The Fed will hold less cash and more securities unaffected by future interest rate hikes. It is hard to imagine the new program won't be the beginning of rapid hikes to pressure the banks. If more banks fail or struggle, the Fed can justify "buying" more securities for the "good of the nation" while raising interest rates to the moon. The Fed can do QE in a high-interest rate environment. If it weren't so evil, one almost needs to appreciate how smart these people are. The Fed can have its cake and eat it too.


What does it mean?

Goldman Sachs changed its interest rate predictions four times within the last month. The market doesn't know what game the Fed is trying to win or understand what just happened. The Fed can now raise interest rates and offset losses on its balance sheet simultaneously. Flooding the market with cash caused the high inflation of the last year. The administration said the response would not be a burden to the taxpayers. Nothing could be farther from the truth. Every Treasury note, bill, and bond burden the taxpayers. The taxpayers won't feel the burden immediately is a more accurate statement.  

Suppose a troubled bank participates in the "loan" program exchanging its securities for cash. Suppose the bank still fails. What does the Fed do with the collateralized security? It flooded the system with cash in exchange for that security. It must sell it to someone to reduce its balance sheet and reduce the predictable high inflation. If they can't sell it back to the bank, who do you think they will want to buy it? In 1933, it was "your patriotic duty" to turn in all your gold for the good of the country. When the Fed runs out of banks to sell securities to, you may have another "patriotic duty" to buy securities enforced by armed IRS agents. I hope I am wrong, but what if I am not?

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Ryan Watkins, Op-Ed ContributorbyRyan Watkins, Op-Ed Contributor
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