The Federal Reserve (Fed) last week proceeded with policy normalization as we expected, raising rates by 0.25%. The Fed’s policy move was fully justified, in our view, despite some of the handwringing regarding rate increases from many market commentators focusing on another weak inflation print.
We believe the central bank’s employment and inflation mandates are effectively accomplished at this stage, when viewed in the proper forward-looking context. Monetary policy is supposed to be forward looking and not overly focused on short-term transitory, seasonally weak data.
It’s also important to recognize that this Fed is normalizing rates from excessively low levels with a keen eye on adjusting the path if U.S. inflation disappoints further. The Fed rightly recognized some of the softness in recent top-line and core inflation (as measured by today’s traditional metrics) and made it clear it will respond accordingly going forward.
Yet we believe the excessive obsession some market watchers have with the Fed hewing to its 2% inflation target is shortsighted. Here’s the truth about the Fed and inflation: The Fed adopted its 2% inflation target only quite recently, in 2012. Prior to that, the central bank was comfortable with an inflation level slightly lower than 2% and looked past the small variations around its previously preferred target range.
Today, massive technological disruptions and long-term demographic trends are remaking the inflation landscape, and we believe both investors and policy makers need to abandon an overly rigid view of price change.
Historically, technological innovation has proved to be deflationary, exerting downward pressure on prices. This is evident in the chart below, showing the drastic drop in computing and storage costs over the last 60 years. Based on the chart below, an iPhone in 1991 storage and computing cost dollars would be worth $1.44 million—per phone. An iPhone today costs a miniscule fraction of that.