OPINION:
At its recent meeting, the Federal Reserve Open Market Committee appeared poised to raise interest rates soon, and Chairman Kevin Warsh established task forces to examine its data and frameworks for controlling inflation.
Since then, concerns about rising interest rates and spending on artificial intelligence have driven significant volatility in stock prices.
Still, this should not concern investors saving for long-term goals.
Since the beginning of the Iran war, the bond market has priced in elevated inflation by demanding higher rates on Treasury inflation-protected securities.
Even if the Strait of Hormuz fully reopened soon, global supply chains would take many months to recover. In Qatar, liquefied natural gas export facilities could take up to five years to build.
Until the threat of terrorist disruption of shipping is fully extinguished, businesses will seek to reduce their dependence on Persian Gulf petroleum, fertilizer, aluminum and other products.
Major oil companies have ramped up exploration and development in Africa, South America, the Mediterranean and Saudi Arabia, and the United Arab Emirates will likely expand pipelines to circumvent the strait.
Rail and trucking routes around the strait are being pressed into service to transport commodities such as phosphate and to bring food and other essentials to Persian Gulf nations.
Diversion, diversification and resilience sacrifice efficiency and push up inflation for aluminum, fertilizer, helium and agricultural commodities.
At the Fed, the change in leadership bears watching.
After he left the Fed Board in 2011, Mr. Warsh campaigned for the chair by criticizing the Fed’s easy-money policies to aid an economy damaged by the global financial crisis, and again in the wake of COVID-19.
In 2025, he flipped to dove by offering a tortured theory that artificial intelligence could rescue us from inflation and enable lower interest rates.
That was before the war broke out, and now sentiment among Fed policymakers is shifting. The next interest rate move likely will be up, not down.
The jobs market is showing new verve. Services, excluding electricity and piped gas, account for 60% of the consumer price index and have persistently registered price increases of 3% or higher.
Between the global financial crisis of 2007 to 2009 and COVID-19, globalization was pulling down goods prices, but now building resilience into supply chains means that the goods sector will add, not subtract, from inflation.
With any positive goods inflation, pulling down the overall CPI to 2% after five years of businesses and consumers adjusting their behavior to elevated inflation, will challenge the Fed.
Mr. Warsh’s response could be that we need new measures and models for inflation.
At his April confirmation hearing, he said, “The data that’s being used to judge inflation is quite imperfect” and “What I’m most interested in is what’s the underlying inflation rate — not what’s the one-time change in prices because of a change in geopolitics or a change in beef.”
He expressed interest in trimmed-mean measures, which, each month, exclude the products and services with the largest price increases and decreases.
At the time of his testimony, the CPI and the core CPI, which exclude food and energy, were 3.3% and 2.6%, respectively.
The Cleveland Fed’s trimmed mean gauge was 2.7%, much in line with the standard measures, but the Dallas Fed’s trimmed mean came in at 2.3% and could justify an interest rate cut.
The problem is that the goods and services that drive inflation often move in sudden bursts, then remain calm for several months, owing to erratic shifts in supply and competitive conditions across sectors.
This makes cherry picking a particular index to justify an interest rate cut poor economics.
Studying the last 10 years, Wells Fargo’s economists found that these measures usually do not “paint a meaningfully different picture of inflation.”
During the 1970s, Fed Chair Arthur Burns had his staff successively remove outliers to justify lower interest rates and disastrous consequences for inflation followed.
First, they took out energy products. In those days, the Bureau of Labor Statistics reported only the headline CPI and did not compute a core inflation measure.
In subsequent months, they bought other food products when fertilizer prices spiked, then still other goods such as mobile homes, used cars, children’s toys and women’s jewelry.
By the time the Fed was done with statistical gymnastics, it was down to only about 35% of the CPI.
It was like Jerome Powell arguing surges in goods prices were transitory in 2021 when President Biden was delaying his nomination for a second term.
Stripping out some prices to appease President Trump with lower interest rates is the road to hell without good intentions, but persistently elevated inflation should not be bad for stocks.
Just as businesses must pay more for materials and labor, they can charge more to increase profits.
Over 40 years before the global financial crisis, inflation averaged 4.0%, real gross domestic product grew 2.9% annually, the 10-year Treasury averaged 7.4%, and the S&P 500 beat them all with a 10.5% annual return.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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