Last Thursday morning the Fed announced a MAJOR POLICY SHIFT ON INFLATION. Instead of setting a hard target of 2% like they have for the last 8 years, the Fed is now going to use “Inflation Averaging”. And they will allow inflation to run higher than 2%; but they didn’t say how much higher.
Fed Chairman Powell said, “We will seek to achieve inflation that averages 2% over time. Therefore, following periods when inflation has been running below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.” Powell did say that short-term rate increases will not happen until the pandemic is brought under control.
But, they did not define a time period for their averaging. For example, inflation is currently averaging 1.3% as of the July Core PCE Report. If the August report shows 2.7% annualized inflation they just hit their average inflation average of 2%. Will this cause them to raise rates? Or inflation has averaged less than 2% for 10 years, does inflation need to average 2.5% or 3% for 10 years before the Fed raises short-term rates? We don’t know. I would imagine the answer is somewhere between these 2 examples.
So, what does this means for you, I, our clients, and all Americans?
- The Fed no longer sees themselves as the INFLATION SLAYER as they were since Paul Volcker in the late 70’s. Paul is probably rolling over in his grave now. I wonder what Greenspan thinks as well?
- We will probably see the Fed Funds Rate and Prime Rate stay where they are at for the next couple of years or longer.
- Dean Baker, senior economist at the Center for Economic and Policy Research said this may allow workers to see larger pay increases before the Fed starts fighting inflation and slowing the economy down.
- Higher inflation rates makes our long-term Treasury debt look cheaper in the future.
- Ditto for mortgage rates. I now have 2 mortgages below 3% and I bet inflation will average over 3% sometime in the next 30 years and when that happens my mortgages may make me money. I may earn 3% or more on my savings and being paying less interest than I am earning. KA-CHING!
- Long-term rates such as mortgage rates will DEFINITELY RISE before short-term rates as bond investors HATE INFLATION as inflation is kryptonite for them. So, if we start seeing the PCE and Core PCE rising near or above 2% annual inflation I fully expect mortgage rates WILL INCREASE!
- Thus, as of right now I do NOT expect mortgage rates to go any lower. Normally mortgage rates run about 1.75% to 2% above annualized inflation. We are below this currently I believe only because the Fed is buying over $5 billion of mortgage bonds a day.
- If the Fed starts buying fewer mortgage bonds and Treasuries we will see mortgage rates rise and they could rise very quickly. I remember earlier this year that rates spiked up over 1% in just 2 or 3 days. This could happen again.
This means waiting to buy your new long-term home/forever home is probably not a smart idea. At the very least it’s probably a riskier idea. Same goes for refinancing your home or rental properties you own. Now’s the time to refinance.
However, here’s my counter argument. The Fed has been trying to get inflation to 2% on a sustained basis for 10 years and they haven’t been successful at doing this. What makes me or you or anyone else think they will be successful now?