WSJ's Greg Ip: Everybody's conviction of 2% inflation has to be lower after what we've seen

Joining us is the Wall Street Journal, Greg Yip. His latest piece is titled Stalled Inflation Vexes the Fed. Is it noise or a new trend? Thanks for joining us. One of the points you make and I should point out moderating inflation rates already been posited by an earlier guest. We had his whole thesis. I don’t know if you saw Tom Lee on earlier, Greg, but he says that he’s bullish, thinks people have gotten way too hawkish on inflation and that those were outliers based on, I don’t know, insurance, auto insurance rates and and a lagging housing market, something like that. But you you feel the same way. What I don’t understand is you say the Fed doesn’t believe inflation is still moderating. Why? Why they keep talking about cuts if they don’t believe it? Well, I think I do. I put it as follows. Is that the January hot inflation number? People said that’s noise. February they said, probably still noise. March, they said maybe it’s not noise, maybe there’s actually a new trend, maybe that’s telling us something. And I think that, you know, the Fed probably is in the same place. Tom is perhaps a little less explicitly. They still think it’s probably noise. They still think it’s going to head back towards 2% before long. I’d say the Friday payroll report, which was soft, probably supports that view. But I think that their conviction on that has got to be lower. Everybody’s conviction that inflation is going back to 2% has got to be lower after what we’ve seen. And I think the real question facing us is that it’s absolutely true that a lot of the upside was in things like car insurance and health insurance, and probably those things aren’t going to be repeated. But what if he took that stuff out? What is it? What’s the trend you’re left with? Do you really think it’s 2%? Maybe it’s 3% because I can make a case out of 3%. Even the soft wage numbers we’ve had to date are closer to more consistent with a 3% inflation rate than a 2% inflation rate. And if that’s the case there isn’t really a strong case for the Fed to cut rates this year and there’s a non zero chance that they may have to raise them. Yeah, definitely. And and you know 2-3. Yeah, close enough for government work. It’s a huge difference and people will tell you that that there’s no way the feds moving the goal posts to three that would be abandoning you know all the you know we’ve canonized Paul Volcker and and what happened back then they want to. They’re not Steve, would they go to 2 1/2? I don’t even think they go to 2 1/2. You mean in terms of their target? I don’t think. I don’t think so. But I I want to speak on the other side of this, which I I look at the numbers and where the Fed is, Joe and I have very, it’s very hard for me to believe the Fed is not restrictive and that these rates are going to pull down inflation. Either it works or the whole thing doesn’t work at all. And I think it does work and I think if you came into this with a, you know, I don’t know what you think the neutral rate is 2% or whatever. And I think the Fed believes that, I think Powell believes that. And I think that the issue is one of more of time than level. And if you think about it, the Fed only hit the peak in peak funds rate around July. So give it a year, we’re coming up this summer. And I do think there is some, as I just reported, a little incipient weakness in the data that bears watching here that might be the moderation that we’re all seeking. Greg, you think we’re restrictive? No doubt. I still have doubts about that. I don’t, you know, but I grew up, I always remember 7 and 8% and and businesses did just fine. And I know we’re up 500 basis points, but historically it just doesn’t seem like we’re that high. I don’t, I don’t know how we know for sure that this is going to do it. Three months ago I was 100% where Steve is. Yes, the federal funds rate of five and a quarter is very restrictive, especially if you think the underlying inflation rate is like two, 2 1/2. That implies a real rate of like 2 to 3%, which is pretty high judging from the last 20 years. Today, I’m not so sure. Let’s say for the sake of argument that the underlying inflation rate is actually 3% as we were discussing. That means the real rate is commensurately lower and therefore not as restrictive. Secondly, as we know is that the restrictiveness of monetary policy, it’s not just about the federal funds rate, it’s about everything. It’s about credit, it’s about spreads, it’s about the dollar, it’s about the stock market. You have an S&P that’s just 2% from its all time high. You know you markets still look pretty buoyant. That doesn’t look really restrictive to me. And here’s the other problem, the Fed has every time the data trend friendly. Sorry, go ahead, Steve. Greg, I’m sorry to try did not to get in too wonky an argument here, but what is so fundamentally changed about the US economy that you would have a double and almost tripling of the neutral rate? That’s what where I get stuck. I look around, there have been changes, but it’s really hard for me to think that the underlying right right rate for for this economy is so much higher. And I mean, over a long period of time, I get that you need an especially high rate to bring down inflation, but why would the run rate be so much higher? OK. So there, I agree with you. I agree that in the long run, the federal funds rate will not be 5 or 5 1/2. So the question is where does it settle at? What’s the neutral rate? Does it settle out at 4, 1/2, four, 3 1/2 or three? And I think that’s kind of where the debate is, right? And I would easily have said it could. It should have been three a few months ago. I’m not, I’m just not so sure right now. I think that as time goes on, we need to appreciate that the period from 2009 to 2019 was the anomaly when we had this so-called secular stagnation and basically nobody wanted to borrow money. And then neutral in that period of time was like 2 to 2 1/2. You needed really low rates to keep the economy going. I don’t think we’re in that period any longer. I don’t think we’re going to be going back to 0 lower bound anytime over the next 10 years. I think that it’s a more inflationary inflation prone world and I think in that world neutral is higher. I think that the markets think the same thing. And if for the sake of argument, it’s actually, or I’m not, I’m just saying putting that out, then it means we only have a percentage point of restrictiveness instead of three percentage points of restrictiveness. And that may explain why we’re having trouble with sticky inflation. I’m just putting that out as a conjecture, Steve. I’m not asserting that that’s necessarily true. But I think that the case for that looks a little stronger today than it did three to six months. Again, Steve. Steve, if you want a scenario for what could get us into that horrible situation of where the Fed stops only to come back later and raise again and then they stop, remember that’s what we all worried about. That’s what happened that one other time. This is the way it would happen. We’d we’d keep thinking, Oh yeah, inflation is it’s just natural. It’s going to come down. It’s going to and it doesn’t. And if it doesn’t, then, you know, then you got to do. I’m not saying that’s going to happen, but it happened one other it it it can happen. And and I don’t know it, it just seems like Murphy’s Law. If you’re going to screw, if it, if it’s possible to screw it up, we’re going to screw it up. There’s another important point here that we can’t forget, which is that if there’s a lot of confidence going on here and for the inflation rate to come back to 2%, people really have to expect that to happen and they have to kind of trust the Fed to do the job. So here’s the kind of the weird thing. If the Fed begins to say, oh, we think it’s going to go back to 2%, we don’t have to do anything. We’re going to cut rates that could actually unsettle expectations and they won’t get that reduction inflation, You know what I’m saying? They kind of have to act like it’s not going back to 2% in order for it to go back to 2%. OK. Well, there’s some, there’s some talk, Joe, that that possibly that was the idea of the introduced cuts into the forecast back in December and the loosening of financial conditions last fall and the winter was part of the reason why you had this spurt of inflation.