The Fed has to be very aware of the danger of leaving things too late: Pantheon’s Ian Shepherdson

Markets are awaiting that key CPI report that's due later this morning. Consumer inflation is expected to show a slight increase on a monthly basis and a rise of 3.4% on an annual basis. That would be similar to the increase that we saw in April. For more on that and today's Fed decision, we want to bring in Ian Shepherdson. He is chief economist at Pantheon Macroeconomics. And Ian, here we go. You expect to be things to be in line with what we just said, up 0.3%. And if so, what does that mean for the Fed? Oh, well, I think it's probably what they expect as well. So I don't think it's going to make any big difference to the decision today or to the tone of the comments from the press conference from Chair Powell. Of course, what we've learned over the last couple of years that these numbers can throw up surprises. So if the core reading X food and energy throws up a .4 instead of a .3, Marcus will be very unhappy and Chair Powell will have some explaining to do. But you know, I think that's unlikely, but I'm, I'm never going to rule it out because these numbers have consistently surprised over the last couple of years as there's a lot of stuff ahead of the number that we just don't know. It's kind of a sort of a black box that we got a guess at and you know, usually it's OK, but it has misbehaved over the last couple of years. So you've got to be a bit careful. Even if it is in line with expectations on an annualized basis, 3.4% is hotter than the Fed would like to see the targets 2%. So how would that possibly pave the way for them cutting rates even if it's in line? It's about a couple of things. It's about direction and belief that the direction will remain on a downward track. It's very bumpy. This is the word that Chapel keeps using. It's bumpy. We can't expect it to get better every month. But as long as they believe that the, the forces that caused inflation to go up a faded away in the pipeline, they'll, they'll eventually get through into the numbers that matter. And the Fed has to be very aware of the danger of leaving things too late because if they wait until inflation gets back to the target and it's still on a downward track and they wait till then before they start cutting interest rates, then they'll have left it too late. This is a problem with with monetary policy that if you wait until you're absolutely certain and almost by definition, you're too late because policy takes so long to then work through in the opposite direction. So they need to make a judgment about whether the trajectory is good enough, even if you're not of the destination that you want to be at. If they're wrong, though, that's a big problem. It cuts into the feds. Yeah. And of course, they were wrong. And it turns out that oh, my gosh, we shouldn't have done it yet. The, the, that's the least resistance is to do. Yeah, of course. You know, and they're very cognizant of the whole transitory fiasco a couple of years ago when they thought that the inflation spike would be brief and it wasn't. And that proved to be disastrous to their sort of collective reputation. Market confidence was lost, and they can't afford to be wrong again in the same cycle, in the same direction. So this has made them a lot more cautious. And previous feds would have been most feds looking back over the last 40-50 years, they start to cut rates before inflation has peaked because they know that what they've done by raising rates will bring it back down again. This Fed didn't do that because of the whole transitory. Why are you so convinced? I mean, when we look around, it looks like there's a lot of liquidity sloshing around. You look at the markets hitting new highs almost every day. You can look at things like Bitcoin that have been above $70,000. That is not suggestive of a really super tight economy, especially when you look at what the consumer's doing. Well, the consumer I think is beginning to slow down a bit now because cash flow has finally slowed down. Last year's cash flow for the consumer was enormous. It ran out like double the long term pace, but but this year things have slowed down. So I think that the softening in retail sales in the last few months probably is the start of something sustained after a long run of upside surprises. But the the important contrast I think is between that those very loose big finance, big sort of big picture financial conditions that you mentioned with the market at you know, new highs And looking at the state of the small business sector which employs half the workforce and small companies are paying 9% for their short term money 9%. So when PPI inflation is about two that means real rates for small businesses 7% which is which is exclusive. No argument that that is a real credit crunch. Yeah, at least in areas of the economy. It's just that it hasn't spread everywhere yet. It hasn't, no. And the consumer with Bank of America and yesterday, the consumer is continuing to spend with their latest readings of 69 million accounts. So consumers and small business that they're looking at, it's being driven by younger people and cash on hand their their cash balances still well above where we were before the pandemic. Yeah. So I'm not suggesting the economy's rolling over. What I'm suggesting is that the slow growth that we saw in the first quarter is probably more representative of where we'll be for the rest of the year than the very strong growth that we saw in the second-half of last year with big surprises to the upside. And from the Fed's perspective, that's that's a risk because the unemployment rate is creeping higher. You know, it's hit 4% now in May, the Fed didn't think we'd get there until the end of the year. So today they'll revise up that forecast. They'll also revise up their inflation forecast. It's kind of a, a weird and unusual combination. But they have to be aware of the risk that that if they leave this squeeze on the small business sector on too tight for too long, then that rise in unemployment accelerates. And before you know where you are, you're looking at a rate that's heading towards 5%. And and that's too high. It puts too much downward pressure on inflation via wages. Not this month, not this quarter, probably not this year, but next year. And, and because of the lags in monetary policy, next year is what they need to be thinking about. Now. This year's inflation story is kind of baked in now, but they're barring some sort of external shock, it's pretty much it's going to do whatever it's going to do. But next year and 26 even is what the Fed needs to be thinking about when they've got their hands on those policy levers today. They're not going to do anything today, but they need to be thinking about the future. When do you think they will cut? September, I hope you know, it depends on we've got two or three more inflation reports before them. We got a couple more payroll numbers. I'm expecting the big May payroll number to be revised down. And looking across the business surveys from the NF, IB, small firms, ISM Services, the PMI, they all have employment measures. Every one of them has weakened quite sharply over the last few months. If they're right, then the next few payroll numbers will be weaker. And then Powell can set something up at Jackson Hole, where presumably he'll make a a speech about policy, and that would open the door to September. But as far as I'm concerned, I'd like them to do it today. They won't.