\nAt this point, you’re wondering where I’m going with this two-week story, which I admit is a bit of a personal obsession. I’m getting to that. The link with our subject is that the Fed is using a similar tactic for its inflation target. We have been above the 2% target for almost five years now. But the Fed continues to forecast 2% inflation… over a two-year horizon.<\/p>\n
<\/p>\n
\nSeptember 2025 economic projections. Source: Federal Reserve<\/p>\n
The credibility issue<\/p>\n
\nBefore we get all worked up and start calling for Jerome Powell to step down, let’s just say that economic projections for the next two years aren’t really worth much. It’s a bit like trying to predict the weather a month in advance. Nobody really knows, so you can pretty much say whatever you want.<\/p>\n
\nThe most important thing for the Fed is inflation expectations. While inflation has been somewhat off track in recent years, inflation expectations have remained anchored, as they say in the jargon, at around 2%. The market has therefore not lost confidence in the Fed’s ability to bring inflation back to its target in the long term.<\/p>\n
\nAt least at this stage, because if it continues to miss its target, that confidence could erode. This issue of inflation expectations is summed up very well by Nick Timiraos, the Wall Street Journal reporter who covers the Fed: “Managing inflation expectations is a bit like a parent trying to enforce a bedtime\u2014if you let it slide too many times, everyone thinks the rules have changed. Credibility requires consistency.”<\/p>\n
\nThe erosion of inflation expectations is therefore a real risk for the Fed. This is because inflation is somewhat self-fulfilling: if everyone thinks there will be more inflation, there will be more inflation. Companies will raise their prices further, employees will demand higher wages, and so on.<\/p>\n
\nSo why not change the target? Because, after all, the Fed’s mandate is price stability. 2% is the target the Fed has set itself to fulfill this mandate, but there is no evidence that 2% is the magic number. Perhaps 2.5% or 3% would be a more appropriate target.<\/p>\n
\nBut once again, changing the target raises the issue of credibility. If you change the target because you can’t achieve the previous one, your credibility is affected. And credibility is a central bank’s most important asset.<\/p>\n
Is a second wave on the way?<\/p>\n
\nWhat makes the current situation uncomfortable is that the Fed resumed rate cuts last week. I say rate cuts because the Fed members’ projections show two more cuts in 2025 and one in 2026. This is a path the Fed is taking even though inflation was at 2.6% last month, according to the PCE indicator.<\/p>\n
\nNot only is inflation quite far from the target, but it has been rising for several months. And this is not limited to just a few categories. 72% of CPI components are above 2%.<\/p>\n
\nAll this while most of the effects of the tariffs are still ahead of us. The Fed’s central scenario is that Donald Trump’s tariffs will not boost inflation in the long term; they will only lead to one-off price increases. This analysis is based on the idea that the labor market is slowing down, which limits wage pressures and second-round effects (price increases that translate into wage increases).<\/p>\n
\nThe coming months will tell us whether this analysis is correct, although what we can already say is that history is not on the Fed’s side.<\/p>\n
\nAccording to the work of Russian economist Nikolai Kondratieff on price trends, inflation follows cycles of 55 to 57 years. This work was published between 1926 and 1928, and we can see that it has been quite relevant: there was a peak in inflation in the 1920s, another in the 1970s, and now one in the 2020s.<\/p>\n
\nMore specifically, periods of inflation are generally characterized by two peaks. This is what we experienced in the 1970s. And when we compare inflation trends during that period with those we have seen in recent years, it is striking to note that we are in the “transition period” for a second peak.<\/p>\n
<\/p>\n
\nSource: Apollo Global Management<\/p>\n
\nWhile history does not always repeat itself, this second wave of inflation is in any case the main risk for investors, according to the latest survey of Bank of America managers. This is ahead of the Fed’s loss of independence, the trade war, and the AI bubble. A second wave of inflation would undoubtedly lead the Fed to raise rates, contrary to the scenario currently being clung to by the market.<\/p>\n","protected":false},"excerpt":{"rendered":"Last week, the Fed resumed rate cuts after several months on pause. Two further 25 basis point cuts…\n","protected":false},"author":2,"featured_media":41131,"comment_status":"","ping_status":"","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[11],"tags":[72,113,61,60,123],"class_list":{"0":"post-41130","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-economy","8":"tag-business","9":"tag-economy","10":"tag-ie","11":"tag-ireland","12":"tag-markets"},"_links":{"self":[{"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/posts\/41130","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/comments?post=41130"}],"version-history":[{"count":0,"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/posts\/41130\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/media\/41131"}],"wp:attachment":[{"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/media?parent=41130"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/categories?post=41130"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.newsbeep.com\/ie\/wp-json\/wp\/v2\/tags?post=41130"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}