Is the Federal Reserve Overestimating Inflation?

Introduction

There is growing concern among analysts that the Federal Reserve may be overestimating inflation and responding too aggressively. This article examines the evidence supporting this concern, including the inverted yield curve and borrowing volume, and explores the possibility of a recession. Additionally, it discusses the optimism surrounding bitcoin and other risk assets due to price increases in 2023.

Is the Interest Rate Too High?

In 2022, there was a significant spike in inflation, prompting the Federal Reserve to respond with aggressive rate hikes. The interest rate increased from 0.25 percent to the current 5.25 percent in just 15 months. Another interest rate hike of 0.25 percent is expected, which would result in an ending rate of 5.50 percent. However, inflation has already decreased considerably, especially when excluding housing. The annual consumer price index (CPI) in the United States, excluding housing, is currently at 0.7 percent. This raises concerns about the Federal Reserve’s tight monetary policy.

Moreover, it typically takes 12 months or more for rate hikes to have their full impact. Truflation, a data source that updates daily based on millions of data points, estimates the current CPI at 2.14 percent. They also indicate that inflation peaked at 11.27 percent in the previous year, significantly higher than the official CPI of 8.93 percent. Based on this data, there are arguments that the Federal Reserve’s current approach is too aggressive and could lead to a deflationary recession in the US economy.

Not the Only Source

Truflation is not the only alternative source of inflation data suggesting that inflation may be lower than what the Federal Reserve believes. The Core Personal Consumption Index (Core PCE) from Federal Reserve data indicates a year-over-year rate of 4.62 percent. However, another alternative source of inflation, PennState, reports a rate of 2.07 percent, closer to the Federal Reserve’s target. PennState’s alternative CPI meter currently stands at -0.86 percent.

Given these alternative measurements, it raises questions about the Federal Reserve’s decision to pursue another rate hike. One would expect Federal Reserve policymakers to be concerned about the state of the US economy.

The Need for Caution

In addition to these alternative inflation measurements, there are other factors suggesting a need for caution. Bank lending is experiencing a significant decline, which cannot be seen in isolation from the rate hikes by the Federal Reserve and the tentative banking crisis of March 2023. Overall, in the current environment, exercising caution is advisable. While the market remains optimistic about the future, the macroeconomic data points in a different direction.