Why is it that the sharp rise in interest rates in the Volcker era is not a manifestation of monetary independence?

1) Volcker was able to raise interest rates sharply to combat high inflation because it catered to political demands.The negative correlation between the support rate and inflation of the four US presidents in the 1970s and 1980s is extremely obvious. In the face of high inflation, President Ford was unable to be re-elected, and President Carter's approval rating fell below 30% in 1979. To turn the tide, President Carter appointed Paul Volcker as chairman of the Federal Reserve. Unfortunately, Volcker was close to the US election when he took office and his hawkish approach led to a recession in 1980, which failed to help Carter reverse the defeat. For Reagan, Volcker was nominated by his predecessor, but it was still in line with his political commitment to fight high inflation.

2) is suppressing high inflation Volcker's only policy objective?The Fed also takes care of the economy and employment.From April to July 1980, after Volcker took office, the Federal Reserve interrupted interest rate hikes and temporarily cut interest rates, during which real GDP growth turned negative year-on-year and unemployment accelerated. The Federal Reserve also cut interest rates during the 1982 recession. In other words, even in times of high inflation, the Fed will strike a balance between economic growth and employment while suppressing high inflation.

Will the long-term stagflation of the 1970s be repeated? The inflection point of inflation in the United States may have occurred. 1)The long-term stagflation in the United States in the 1970s is the result of strong demand, manufacturing transfer, and supply shock resonance, which is difficult to reappear at present.2）Us inflation may have peaked in March.

The switch of the Fed's monetary policy anchor in the Powell era: "fiscal" before September 2021; "high inflation" since September 2021; sometime during the year (expected from the end of Q2 to Q3) may turn to hedge "US stock market decline + economic slowdown".

1) the Fed's policy anchor before September 2021 is fiscal.Until September last year, the Fed always said that high inflation was temporary and unsustainable because the policy anchor at that time was fiscal. On March 11, 2021, the Biden administration implemented the third round of post-epidemic financial transfer payment policy. The United States maintained a high fiscal deficit in the following months, so the Federal Reserve was unable to Taper and raise interest rates. Under fiscal constraints, the Fed cannot acknowledge the persistence of high inflation.

2) switch of Fed policy anchor in September 2021: fiscal → high inflation. The pressure on US fiscal bond issuance eased in the middle and late period of Q3 in 2021, while President Joe Biden's approval rating plummeted as inflation rose. As a result, the Fed's monetary policy anchor has shifted from helping the Treasury drive down the cost of debt spending to suppressing inflation.

3) since inflation is about to peak, why raise interest rates by 50BP in May?This precisely shows that the Fed does not have much room to raise interest rates, so that if inflation does not top, it cannot raise interest rates 50BP in a single meeting. After the US CPI and other inflation indicators are released from April to May and prove the fact that inflation is cooling, the Fed can not only affirm itself but also re-ease monetary pressure.

4) reiterate that the Fed's interest rate hike cycle is likely to stop by the end of the year.Once the economy takes a turn for the worse and there is a risk of recession or US stocks plummet, inflation is no longer the main contradiction in the Fed's monetary policy. Looking back, on the one hand, the US economy slows down in the second half of the year, and the risk of recession next year is higher; on the other hand, the risk premium of US stocks has turned negative, and the pressure on adjustment is increasing. In turn, there is a high probability that the Fed will end raising interest rates by the end of the year.

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First, why is it that the sharp rise in interest rates in the Volcker era is not a manifestation of monetary independence?

(1) Volcker was able to raise interest rates sharply to combat high inflation because it catered to political demands.

Many market participants believe that the Volcker era curbed high inflation by raising interest rates sharply because the Fed's monetary policy was more independent. But we believe that Volcker raised the federal funds rate from about 10% to 20% in the early days of his tenure (1979-1980). It was "politically correct" to raise the benchmark interest rate twice in 1981 to about 22% after a brief cut in May-August 1980. The reason is simple: the chairman of the Federal Reserve is nominated by the president.

As shown in figure 2, the negative correlation between the support rate and inflation of the four US presidents in the 1970s and 1980s is extremely obvious. Not only is it normal to open high and go low, as long as the term of office inflation is high, the support rate is bound to fall off the cliff. Even Watergate did not seem to have hit Nixon's approval ratings as much as inflation. In the face of high inflation, President Ford was unable to be re-elected, and President Carter's approval rating fell below 30% in 1979. In order to reverse the declining popularity of his term of office, President Carter delivered a famous speech "crisis of confidence" on July 15, 1979, then replaced all 13 members of the cabinet and appointed Paul Volcker as chairman of the Federal Reserve. In other words, Volcker was appointed to take over the Fed in the face of crisis in order to curb high inflation and boost the government's credibility.

Unfortunately, Carter did not have much time, and his approval rating was depressed again when US inflation was still rising when he began to campaign for the general election in early 1980. In the 1980 US election, Reagan won a resounding victory because of his promise to curb high inflation, and the Fed led by Volcker continued to raise interest rates sharply after Reagan took office is a symbol of Reagan's campaign promise. Although Volcker was nominated by Carter, Volcker took office at a time when the US election was approaching and his hawkish approach led to a recession in 1980, which failed to help Carter reverse the defeat. For Reagan, Volcker was nominated by his predecessor, but it was still in line with his political commitment to fight high inflation. Volcker's tight monetary policy also led to the 1982 recession and a sharp drop in Reagan's approval rating, but Reagan regained public support after the US economy stabilized and inflation fell to a low level in 1983.

(B) is suppressing high inflation the only policy objective of Volcker? The Fed also takes care of the economy and employment.

From April to July 1980, after Volcker took office, the Federal Reserve interrupted interest rate hikes and temporarily cut interest rates. Combined with figure 3-6, we can see that during the Fed interest rate cut, the real GDP growth rate in the United States turned negative year-on-year and the unemployment rate accelerated. When the economy rebounded and unemployment fell, the Fed started to raise interest rates again. The Federal Reserve also cut interest rates during the 1982 recession. In other words, even in times of high inflation, the Fed will strike a balance between economic growth and employment while suppressing high inflation.

Second, will the long-term stagflation of the 1970s be repeated? The inflection point of inflation in the United States may have occurred

The long-term stagflation in the United States in the 1970s was the result of strong demand, manufacturing transfer and supply shock resonance, which is difficult to reappear at present.. First, baby boomers born between 1970 and 1980 were transformed into a "demographic dividend" in the United States, and the rise of these young people spurred consumer and real estate demand. In addition, the proportion of the middle class in the United States was more than 60% in the late 1960s and early 1970s (it is now less than 50%), which provided a further boost to American consumption. But high costs led to a massive shift out of American manufacturing in the 1970s. Coupled with the supply shocks triggered by the two oil crises and the depreciation of the dollar, the United States experienced long-term stagflation. At present, the demographic structure and the proportion of the middle class in the United States are not the same as those in the 1970s, and Biden's emerging industrial strategy will also lead to a rebound in the share of manufacturing, so that the United States does not have the basis for persistently high inflation or even stagflation.

Us inflation may have peaked in March.Since Q4 last year, high inflation in the United States has been mainly driven by three sub-categories: energy, used cars and housing. In March, US CPI hit a new high of 8.5 per cent year-on-year, but the three main reasons are still the above. However, the price increase in CPI in March focused on the energy sector, which will be reversed in April as long as the situation in Russia and Ukraine is stable. The contribution of the sub-item of used cars (transport products, excluding car fuel) to CPI in March has turned negative compared with the previous month, indicating that the structural inflation contradiction caused by the epidemic has been significantly alleviated. With the rise of the base, the CPI contribution of used cars to Q2 will also be significantly weaker than the same period last year. The contribution of residential inflation to March is not higher than that in February, indicating that the sub-item is relatively stable. As the growth rate of US house prices peaked in May-July last year, the CPI residential sub-item is expected to decline at the end of Q2 this year. Overall, US CPI may have peaked in March compared with the same period last year.

III. The switch of the Federal Reserve's Monetary Policy Anchor in the Powell era

(1) has the Federal Reserve misjudged high inflation?

Before September last year, the Federal Reserve always said that high inflation was temporary and unsustainable, so it failed to tighten money in time. The market generally believed that this was a policy mistake caused by the Fed's misjudgment of the inflation situation. But we think the reason why the Fed denies the persistence of high inflation is that the policy anchor at that time was fiscal. On March 11, 2021, the Biden administration implemented the third round of post-epidemic financial transfer payment policy. The United States maintained a high fiscal deficit in the following months. The QE operation of the Federal Reserve after the financial crisis and after the epidemic is a means to monetize the fiscal deficit, which is intended to help the US Treasury drive down the cost of debt spending through bond purchases. In turn, the Fed is still unable to Taper and raise interest rates just two quarters after the third round of fiscal transfer payments. The problem that cannot be solved is not a problem, and the Fed cannot acknowledge the persistence of high inflation in the context of its inability to tighten money.

(II) the switch of Fed policy anchors in September 2021: fiscal → with high inflation

The pressure on US fiscal bond issuance eased in the middle and late period of Q3 in 2021, while President Joe Biden's approval rating plummeted as inflation rose. As a result, the Fed's monetary policy anchor has shifted from helping the Treasury drive down the cost of debt spending to suppressing inflation. Combined with the previous article, we can see that high inflation has a fatal blow to the president's power, so reversing inflation after the lifting of fiscal constraints has become an urgent task for the Fed's monetary policy. Against this backdrop, the Fed began Taper on Q4 last year, raised interest rates for the first time in March this year, and gave forward guidance for raising interest rates by 50BP in May and launching a contraction table. Given that inflation has not cooled, Mr Biden's approval ratings remain low during his term of office, prompting the Fed to signal faster tightening.

(C) since inflation is about to peak, why do we have to raise interest rates by 50BP in May?

In his speech on Thursday, Powell praised Volcker for defeating high inflation, indicating that the Fed also has the determination and courage to fight inflation. In addition, Powell also gave forward guidance for the Fed's 50BP rate hike at the FOMC in May. Since US inflation is about to peak, why did the Fed FOMC raise interest rates by 50BP in May? We think this precisely shows that the Fed does not have much room to raise interest rates, so that if inflation does not top off, it will not be able to raise interest rates 50BP in a single meeting. Logically, once the Fed starts to raise interest rates with a single FOMC 50BP, as long as inflation does not peak, the Fed must maintain the pace of raising interest rates at every meeting of the 50BP, or surrender to high inflation.

There is a high probability that the US economy will slow this year and the real GDP annualized rate of Q1 and Q3 will turn negative next year. In addition, the risk premium for US stocks has fallen below the zero axis. At present, neither the US economy nor the stock market can afford to raise interest rates many times, so the Fed will not be able to raise interest rates in a single meeting without inflation, but if inflation shows signs of peaking, the Fed will instead take more aggressive action to raise interest rates in order to demonstrate its determination to fight inflation. After the US CPI and other inflation indicators are released from April to May and prove the fact that inflation is cooling, the Fed can not only affirm itself but also re-ease monetary pressure.

(4) reiterate that the Fed's interest rate hike cycle will probably stop by the end of the year.

According to experience since the 1980s, interest rate hikes will end within 3-6 months after the 10-year and 2-year Treasury yields are upside down. Yields on 10-year and 2-year Treasuries were upside down in early April, heralding the possibility of an end to Q3 interest rate hikes. In addition, once the economy takes a turn for the worse and there is a risk of recession, inflation is no longer the main contradiction in the Fed's monetary policy. The inflation centre is moving up during the period from September 2007 to January 2008 and from September 1989 to November 1990, and another common feature of these two stages is that the economy begins to slow and move towards recession. The shift in policy attitude in Q1 Powell from Q4 in 2018 to 2019 even suggests that the Fed will stop raising interest rates as long as US stocks adjust sharply. That is to sayOnce the economy takes a turn for the worse and there is a risk of recession or US stocks plummet, inflation is no longer the main contradiction in the Fed's monetary policy. Looking back, on the one hand, the US economy slows down in the second half of the year, and the risk of recession next year is higher; on the other hand, the risk premium of US stocks has turned negative, and the pressure on adjustment is increasing. In turn, there is a high probability that the Fed will end raising interest rates by the end of the year.