Last week, the Federal Reserve engaged in an aggressive round of policy tightening, raising the policy rate by 75 basis points (although just weeks before, Chairman Powell had openly stated that the Committee was not actively considering such a scenario). Apparently, they did so passively.

The real yield on 5-year inflation-protected government bonds (TIPS) rose 44 basis points over the week, and the real yield on 10-year bonds rose 28 points. The main leg of the rally occurred prior to the Fed meeting on leaked rumors that the FOMC was actually going to raise the benchmark rate by 75 bps.

Since March, real 5-year bond yields have risen 220 points and 10-year bond yields have risen 170 points. This has and will continue to put pressure on the stock market.

Bonds, of course, have also suffered. The classic 60/40 portfolio (60% stocks, 40% bonds) is down 18% since January. The “risk parity” approach has been even more unsuccessful: the Toroso Risk Parity ETF (NYSE:RPAR), for example, is down 20.6%.

Real yields on 5- and 10-year bonds

But help is on the way, right? 5- and 10-year inflation swaps fell 25 and 20 basis points respectively this week, approaching levels prior to the Russia-Ukraine conflict. This is a clear reaction to the Fed’s actions, but much of the decline from April’s localized highs is due to the carry trade. In fact, projected price levels did not decline at all until this week. The chart below shows the theoretical price of Consumer Price Index futures for December 2027 (if they existed.

“CPI Futures.

Source: Enduring Investments

Still, the decline in market inflation expectations may reassure the Fed that the regulator has made some progress in “unshackling inflation expectations” and keeping price pressures from spiraling out of control.

Unfortunately, the central bank may be wrong about that. I wrote last week that by raising rates and ignoring bank reserves, the Fed is only regulating the cost of money, not the quantity of money. We have never before fought inflation in this way.

Personally, I consider the volume of the money supply a more important indicator than the cost of money, and it is unlikely that the current approach can sufficiently soften the blow we are all told to expect. Certainly at some point inflation will begin to fall due to the base-comparison effect, but we shouldn’t let them take a lap of honor until the core CPI is below 3% on an annualized basis (and I’m not ready to start slicing confetti just yet).

Meanwhile, the Administration is ranting about the incredible profits of the oil companies. In his letter, President Biden stated that “the vastly higher than normal profits of oil refineries are being passed directly onto American families, which is unacceptable.” (This criticism followed his recent statement that “Exxon (NYSE:XOM) has made more money this year than the Lord God himself.” Frankly, the rising tide of murders and suicides suggests that Exxon may be doing better than God).

And while that’s partly true, this state of affairs is largely the result of the president’s own policies: the huge demand generated by the stimulus payments is putting upward pressure on gasoline consumption, while the release of oil from the strategic reserve has kept commodity prices somewhat in check.

Surging refining margins are exactly what you need if you’re trying to get oil companies to increase utilization. Is the resulting paradox an accident? Biden’s letter also threatens, “If necessary, I am prepared to use every tool at my disposal to remove obstacles to an affordable and reliable energy supply for Americans.”

In May, the House passed legislation that gives the president the power to declare a national emergency and makes it illegal to “excessively” raise the price of gasoline or other fuels consumed by households. Looks like price regulation, doesn’t it?

Pieces of the puzzle…

On the one hand, it seems silly to waste time talking about price regulation. This approach doesn’t work both in theory and in practice (believe me, many have tried). By setting prices below the market price, we provoke shortages, not to mention a reduction in government revenue due to the emergence of a black market (where cryptocurrencies, for example, can shine!). This is a known fact.

It’s silly to even debate this topic. The only thing that can be achieved by price regulation is to temporarily reduce inflation figures….

A lot of things become clear, don’t they?

It also seems silly to discuss the “excess profits tax” on oil companies that the Administration and others accuse of exacerbating the inflationary crisis by “jacking up prices” (as if any company has enough power in the world market to single-handedly jack up the price).

Again, this hasn’t worked in the past; the theory is that such a tax should lead to lower production: with 1 billion barrels of proven reserves, a company is more likely to increase production when it is sufficiently profitable, which is contradicted by the idea of artificially holding down prices.

Lower profits would also limit exploration and lead to structural price increases, causing a shortage of non-electric drivers.

Once again, the Administration’s vector becomes clear.

I said on a TV program last week that sometimes it can be difficult to distinguish between incompetence and malice. Personally, I want to believe that people usually have good intentions; it’s the execution that is flawed.

The problem is that it’s getting harder and harder to believe the colossal incompetence required to put Modern Monetary Theory, price controls, and punitive taxes on fuel production into practice. I can believe that former Fed Chairman Bernanke did not see the housing market bubble because he had no personal gain in turning a blind eye to it. Modern Monetary Theory was also something I wanted to believe.

Things are different now: putting “incompetence” aside, price controls and the excess profits tax become elements of a terrible economic policy that has a beneficiary.

In the medium term, inflation will continue to accelerate, not decline, because policy does nothing to address the causes of price pressures, with price and output controls contributing to the imbalance.

In the end, we can only hope that our policymakers are “merely” incompetent.