John Hussman: The Fed's Talking the (Anti-inflation) Talk to Avoid Walking the Walk

by: John Hussman

Excerpt from fund manager John Hussman's weekly essay on the U.S. market:

Given continuing inflation pressures and an otherwise unambiguous tightening bias, whatever room the Fed left open for policy change was clearly to allow flexibility in the event that the housing market deteriorates profoundly. A Fed cut is likely to be put into practice only under conditions that nobody would wish on this economy...

Despite persistent inflation pressures, the Fed can't easily raise rates further because that might add to the instability in the housing sector. So it has to manage inflation expectations verbally, while also backing away from its preferred inflation targets and accepting higher ones instead.

And that's exactly what Fed Governor Frederic Mishkin did on Friday night at a speech in San Francisco. He noted that getting inflation into the "comfort zone" of 1-2% could involve higher interest rates and "considerable output and employment losses." So instead, the Fed is relying on the public's expectation that inflation will remain "anchored" around 2%. Mishkin noted "I am less optimistic about the prospects for core PCE inflation to move much below 2% in the absence of a determined effort by monetary policy," adding that "a substantial further decline in inflation would require a shift in expectations, and such a shift could be difficult and time-consuming to bring about."

Do those sound like remarks from a Fed that's eager to ease monetary policy?

Though my view remains that Fed actions are largely irrelevant to the volume of lending activity, there's no question that they have a psychological effect. Currently, my impression is that Wall Street has largely misinterpreted the Fed's language, and that its interpretation will be subject to an "ongoing adjustment" in the weeks ahead.