Inflicting Pain

Mike Zaccardi

FEDERAL RESERVE CHAIR Jerome Powell, speaking last Friday at the Jackson Hole Economic Symposium, said that bringing down inflation will mean “some pain” for households. But what sort of pain are we talking about?

Powell and the rest of the Fed members are hoping to create “tight conditions.” That isn’t some opaque description of the economy and financial markets. Instead, the term has four specific components that help dictate Fed policy.

  • The U.S. dollar. A stronger greenback slows economic growth by making domestic goods more expensive for foreign buyers. Net exports, a factor in determining GDP, often drop when the dollar rises. With the dollar near 20-year highs, the currency market is working in the Fed’s favor.
  • Corporate bond yields. When interest rates climb, corporate borrowing and investment slow. The Fed won’t be thrilled by what’s happening here. The spread between high-yield “junk” bonds and Treasury bonds, after easing during the summer, is now widening once again. But the spread between higher-quality corporate bonds and Treasurys remains modest by historical standards.
  • Stock market performance. This component is as basic as it sounds. Lower stock prices sometimes lead to reduced consumer spending, because folks feel less flush—what’s called a “wealth effect.” The upshot: For now, the Fed might want to see the bear market continue.
  • Interest rates. For consumers, higher borrowing rates stifle spending, including spending on home purchases. Look no further than the state of the real estate market, where sales seem to be slowing sharply amid plunging housing affordability. As of last week, the average rate on a 30-year conventional mortgage was 5.73%.

We can think of the current period as a hangover from 2021’s binge of stimulus and speculation. Today’s high inflation is the price we’re all paying, and the Fed is hell-bent on taming it. The good news: Expected inflation is at its lowest level since January. Investors and traders are pricing in much softer inflation readings for the next five years. But getting to those lower inflation rates will likely require some pain.

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