The bullet points we mentioned do all contribute to inflation. But there is another less popular explanation for this latest move higher: Maybe the Federal Reserve is getting its monetary policy wrong and should not be cutting interest rates.
Should that really be so hard to believe? Fed Chair Jerome Powell, who quarterbacks our central bank, filled the same role three to four years ago when the Fed made what we now accept as an obvious mistake. The Fed in 2021 kept its benchmark interest rate near zero despite soaring economic growth (U.S. GDP +5.8%). It wasn’t until March 2022 that the Fed began hiking. By then, annual inflation was approaching 8%, and the Fed was chasing an animal it had helped unleash.
Recency bias makes it easy to credit Powell and the Fed for sticking the proverbial “soft landing,” meaning they corralled inflation without triggering a recession. But that victory might not last if policy becomes too dovish too quickly.
It’s not a coincidence bond yields hit an 18-month low two days before the September Fed cut and have been rising ever since. Investors are conditioned to think lower interest rates are better, but the bond market is reminding us stimulus comes with side effects.
The Fed, at least, has taken notice and adjusted its 2025 guidance to reflect fewer rate cuts in the year ahead. As a result, meaningfully lower mortgage rates and the death of inflation narratives (like this one) will take longer to achieve.
In the big picture, those sacrifices will seem small if it means Powell and his Fed governors have learned their lesson. Perhaps there will be fewer policy mistakes this time. Perhaps the recent inflation bump will prove transitory.