On My Mind: Fed and Inflation: You Can’t Always Get What You Want

The Fed seems to have been caught by surprise by its own policy and says this is not the inflation it was looking for. Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income, shares her thoughts on why inflation should not have come as a surprise and why investors need to brace for higher volatility as the Fed adjusts its policy stance.

I used to live in London in an earlier phase of my professional career. I loved London, and still do, for many reasons—bear with me, I promise this will bring us back to the Federal Reserve (Fed). One thing I did not love as much was the frequent delays on the tube—the subway train system. During the fall, the public system announcement would often explain that the trains were running very late due to…leaves on the tracks. This was met with polite surprise, as falling leaves in autumn could hardly be considered an unexpected phenomenon. Investigative journalism eventually revealed that yes, falling leaves in autumn had been anticipated, but those that fell on the tracks were the wrong kind of leaves.

I thought of this when Fed Chairman Jerome Powell said at the latest Federal Open Market Committee (FOMC) press conference: “the inflation we got is not at all the inflation we were looking for.”

Much like the leaves on London’s train tracks, this announcement has generated amused puzzlement and a measure of sarcasm. And much like in the case of London’s leaves, it is useful to understand what went wrong.

As Powell explained it, the Fed hoped that above-target inflation would eventually result from running the economy too hot for some time, above full employment levels. Instead, inflation has soared to nearly 7% before full employment has even been reached, in the Fed’s view. Blame supply chain disruptions, the “wrong kind of leaves” that have suddenly blocked the smooth transiting of goods and caused an unexpected surge in prices. Unforeseeable, and certainly not the Fed’s fault, right?

But just like London’s wrong kind of leaves, this sounds a lot more like an excuse than an explanation.

Yes, global supply chains suffered a sudden shock. But when early last year the global economy shut down and countries started imposing arbitrary and ever-changing restrictions on travel, transportation and business activity, a curious mind could have guessed this would impact supply. The fact that extraordinarily loose monetary policy, combined with a rebound in pent-up demand, a massive fiscal expansion and supply restrictions would result in higher prices should not have come as such a surprise.