Market Extra: Behind highest U.S. inflation rate in 31 years lurks fear that Federal Reserve has `lost control’ of consumer prices

After months of complacency in financial markets, the highest U.S. inflation rate in almost 31 years is now raising fears that it may keep accelerating and that the Federal Reserve may have already missed its best chance at keeping prices stable.

In the aftermath of Wednesday’s consumer-price index reading, showing a 6.2% headline year-over-year rate for October, investors flocked to hedges like gold and digital currencies, while one major investment firm was raising the prospect of a 7% CPI reading in the next several months, and the Federal Reserve’s well-worn “transitory” narrative about inflation was being called into question.

Mounting alarm was evident in Wednesday’s substantial selloff of Treasuries, the asset class hit hardest by inflation, which sent the 10-year

and 30-year yields

to their biggest one-day advances in months. A gauge of inflation expectations for the next five years, known as the 5-year breakeven rate, also hit a record high. Meanwhile, investors like Jay Hatfield of Infrastructure Capital Advisors, along with Stifel Chief Economist Lindsey Piegza, are warning the Fed has “lost control” of inflation.

“The Fed has absolutely lost control of inflation and inflation expectations, or at least it appears that way,” Piegza said via phone Thursday. “Policy makers arguably should have moved a lot sooner to pull back on easy policy earlier this year, when inflation was showing signs of persisting beyond what most economists would be comfortable with, even temporarily.”

“But they continued to stick with their assessment that this is transitory,” she said. “The fear is not that they won’t be able to rein in price pressures eventually, but that now they may have to move at a faster pace than they would have otherwise needed to. By waiting so long, they’ve created an even more difficult challenge for themselves.”

The Fed’s best tool for combating inflation may be a hike in its benchmark policy interest rate, which isn’t likely to happen until next year at the earliest and may not even impact the economy until 2023 given long, variable lags in policy. The central bank has taken the first step to tighten policy by starting to pare its monthly bond purchases over the next few months. In the meantime, annual headline CPI readings have come in at 5% or higher for six straight months, well above the Fed’s 2% target.

Wednesday’s CPI reading was enough to get Newport Beach, California-based bond-fund giant PIMCO to reevaluate its own expectations.

After revising its fourth-quarter CPI forecast higher in the past month, PIMCO revised its forecasts once again on Wednesday after the U.S government data was published. The firm now sees annual core CPI, which strips out food and energy, peaking at 6% and hitting 5.6% and 2.6%, respectively, at the end of 2021 and 2022, said Tiffany Wilding, PIMCO’s North American economist. PIMCO also sees the headline CPI rate as likely reaching 7% over the next several months.

In June, she and Andrew Balls, PIMCO’s chief investment officer for global fixed income in London, stood by the view that price pressures would prove to be transitory and said they expected inflation in developed markets to peak in a matter of months.

A 7% CPI reading is “not outside the realm of possibilities,” Stifel’s Piegza  said. Making matters worse is the potential for a new head of the Fed next year to succeed Chair Jerome Powell, she said. “I really am extremely concerned about the increasing political influence on monetary policy in general — but also specifically to keep rates low — and that the Fed is taking this permanent, passive position on the sidelines by allowing politicians to dictate the appropriate path for policy.”

U.S. Treasury markets were shut on Thursday due to the Veterans Day holiday, but stocks continued to trade. The S&P 500

and Nasdaq Composite Indexes
which have grown increasingly insensitive to inflation, recovered some ground after losses earlier this week, while the Dow industrials slipped below 36,000 in morning trading on poor quarterly results from Walt Disney & Co.

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