As the Federal Reserve embarks on a new campaign to raise inflation rates, markets may be in for a change in character.
On Wednesday, Fed Chairman Jerome Powell announced that the central bank would be targeting an inflation “average” of 2%. By the Fed’s measures, inflation has been running below 2% in recent years. So, getting to a 2% average in the years ahead will require above 2% inflation for a significant period.
Here’s Powell attempting to explain himself from central bankers’ virtual Jackson Hole conference:
Jerome Powell: Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer term inflation expectations remain well anchored at 2%. However, if inflation runs below 2% following economic downturns, but never moves above 2%, even when the economy is strong, then over time, inflation will average less than 2%.
Households and businesses will come to expect this result. Meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down. To prevent this outcome and the adverse dynamics that could ensue, our new statement indicates that we will seek to achieve inflation that averages 2% over time.
If Jerome Powell and company are successful in jacking up consumer price levels, the implications for holders of bonds and cash are dire. Anyone who holds savings in a money market account or a U.S. Treasury security of any maturity stands to suffer real losses year after year.
Not even the 30-year Treasury sports a yield as high as 2%. Bond yields did rise sharply on Thursday following Powell’s jawboning.
Earlier this month, Fed officials had disappointed the bond market by backing off on yield curve control. That signaled they would allow long-term yields to rise even as they hold short-term rates near zero.
The 30-year Treasury hit 1.5% yesterday. It still has a long way to go to get to a positive real rate in environment