The Federal Reserve is on track to tighten its monetary policy soon in a context where inflation kept surprising upward both economists and the White House. Rising inflation has become the main concern of households for several months and has weighted on real personal consumption expenditures. In the meantime, Joe Biden’s rating approval has fallen like a knife, which explains why his administration has added huge pressure on Fed policymakers to act aggressively ahead of midterms. In the meantime, there are more and more signs that a wage-price spiral is gaining traction with low-income families asking for higher salaries.

Inflation Kept Surprising Upward Both Economists And The White House

In January, the consumer price index (CPI) climbed 7.5% YoY (fastest since February 1982 and up from 7% in December), according to Labor Department data released Thursday. Excluding the volatile food and energy components, core prices increased 6% YoY (fastest since August 1982 and up from 5.5% prior).

Both measures came above expectations (7.3%e and 5.9%e respectively) but the real surprises came from MoM measures. A few days before the release of CPI figures, the White House said that “individuals should focus on the month-over-month increase, rather than the annual jump, considering what we’ve seen over the last year.” Reality is that CPI rose 0.645% MoM in January (above average consensus of 0.44%), implying an annualized rate slightly above 8.0%. In other words, the recent dynamic is stronger than the YoY trend.

Taking into account weight updates, first data for February related to energy prices and continued momentum in services categories like shelter, the YoY print will probably keep rising in February. Figures should be released on March 10th, a few days ahead of the next Federal Reserve meeting (March 16th), and should add further pressure on policymakers to act.

Inflation Has Become The Primary Concern Of Households And Has Affected Biden Approval

According to several surveys, inflation has become a primary concern for households. As an example, the University of Michigan’s sentiment index dropped to 61.7, the lowest since October 2011 and down from 67.2 in January according to data released Friday.

In the details, consumers expect an inflation rate of 5% over the next year, the highest since 2008 and up from 4.9% in January. They expect prices will rise at an annual rate of 3.1% over the next five to 10 years, unchanged from prior. In this context, 26% of respondents expected their financial prospects to worsen, the highest share since 1980.

U.S. consumer sentiment fell further in early February to a fresh decade low, according to a University of Michigan index (via @jordan_yadoo) https://t.co/J5WOTEC0he

— Bloomberg Economics (@economics) February 11, 2022

🇺🇸 "The impact of higher #inflation on personal finances was spontaneously cited by one-third of all consumers, with nearly half of all consumers expecting declines in their inflation adjusted incomes during the year ahead." pic.twitter.com/8hKqJ91IsZ

— Christophe Barraud🛢 (@C_Barraud) February 11, 2022

It’s also feeding through into more negative views about President Joe Biden’s agenda as poor government economic policies were cited by 51% of respondents, the highest share since 2014. In the meantime, most of polls confirmed that Biden’s approval rating has fallen like a knife ahead of midterms (November 8th) and is now below Trump’s at this time in the presidency. 

🇺🇸 #Biden’s Approval Rating Tumbles While #Gasoline Prices Keep Surging - Bloomberg
*Link: https://t.co/7YyJrMeIUh pic.twitter.com/GI6oCQ5c0c

— Christophe Barraud🛢 (@C_Barraud) February 9, 2022

Biden vs Trump approval rating at this time in their administration pic.twitter.com/VqR4VEsJ2i

— zerohedge (@zerohedge) February 10, 2022

Without surprise, Joe Biden has become very nervous about inflation especially in a context where his advisors finally admit that this phenomenon can no longer be considered as “transitory”. As a matter of fact, France24 reported “he was caught on a live microphone Monday calling a Fox News journalist a “stupid son of a bitch” on the sidelines of a White House photo op.” As a result, it’s easy to imagine that he will add maximum pressure on Federal Reserve policymakers to act quickly and strongly. 

The Federal Reserve Will Be Also Forced to Act Due The Formation Of A Wage-Price Spiral For Low-Income Families

In a context where the labor market is probably tighter than indicated by the unemployment rate (at 4.0% in January 2022), there are more and more signs that a wage-price spiral is gaining traction with low-income families asking for higher salaries.

The January employment report highlighted that, in the private sector, wages growth of “production and non-supervisory employees” increased by 6.9% YoY (fastest since April 2020 and well above the headline of 5.7% for all employees). In addition, the NFIB survey showed “A record 50% of U.S. small-business owners said they raised compensation in January“.

🇺🇸 Average Hourly Earnings for production and nonsupervisory workers in the private sector ⬆ 6.9% YoY in Jan. (fastest since Apr. 2020).
*It confirms that the risk of a wage-price spiral is now real with low-income families asking for higher salaries (https://t.co/NMnwBgil4C) pic.twitter.com/IFZySuFSGL

— Christophe Barraud🛢 (@C_Barraud) February 4, 2022

Other studies confirm that low-income families are experiencing strong wage gains. The Atlanta Fed’s Wage Growth Tracker for the first quartile (the lowest 25%) is rising at the fastest pace in almost 20 years and almost twice as fast as for the fourth quartile (the highest 25%).

The trend is unlikely to ease as low-income families are expected to ask for more wage increases because they will face a huge shock of inflation this winter. The fact is that several analysis highlight that excess savings (accumulated during the Covid crisis) among many working- and middle-class households could be already exhausted. 

🇺🇸 The basket of consumption of the 1st decile (very # from the mean & the last decile) is tilted towards:

YoY change (Nov.):
*Rents (Apartment List): +17.7%
*Gasoline (CPI): +58.1%
*Natural Gas (CPI): +25.1%
*Electricity (CPI): +6.5%
*Food (CPI): +6.1%https://t.co/eE6ZiIvAnW

— Christophe Barraud🛢 (@C_Barraud) December 13, 2021

Moreover, as I already noted, one of the key problem is that the spike of rents (the largest spending item of low-income families) seems durable, especially in a context where occupancy rate recently hit a new record. 

🇺🇸 #Housing #Rents #Fed | Overall occupancy in professionally managed apartments hit another new record in January 2022 at 97.6% - RealPage
*Occupancy tops 96% in 146 of the nation’s 150 largest metro areas.https://t.co/mK0FhaVVwy

— Christophe Barraud🛢 (@C_Barraud) February 5, 2022

The Federal Reserve Will Act By Raising Rates and Shrinking Balance Sheet

Facing political and inflationary pressures, the Federal Reserve is expected to tighten its policy soon by raising rates for the first time since December 2018. In addition, it seems that the Federal Reserve will also start to shrink the balance sheet.

As a first step, policymakers are likely to let bond holdings run off the balance sheet as they mature but then, as suggested by Philadelphia Fed President Patrick Harker, Kansas City Fed President Esther George and St. Louis Fed President Jim Bullard, there is case for selling assets, more precisely Mortgage-Backed Securities (MBS). In its new “Principles for Reducing the Size of the Federal Reserve’s Balance Sheet“, the Federal Reserve omited a key sentence used in the 2014 Quantitative Tightening announcement, namely that “The Committee currently does not anticipate selling agency mortgage-backed securities as part of the normalization process“.

This scenario looks credible because inflation will remain well above the 2% target in the coming months in a context where rents will support the headline. As a reminder, Fed measures to assess the dynamic of the rental market tend to be “sticky” relative to market-based rental costs and also lagged them during expansionary periods.