Davos elites fear ‘Volcker Moment’ as central banks draw their swords

The collective warning from Davos is that all-powerful central banks are no longer on your side, so don’t tempt fate by reflexively buying the dips.

The monetary gendarmes have let the inflation genie out of the bottle and will have to squeeze markets until the pips squeak in order to stop it now running wild across the major western economies.

“The ‘Fed Put’ is over. They don’t mind what happens to markets,” said Jason Furman, former chairman of the White House Council of Economic Advisers.

He warned that rates will have to go much higher than the Federal Reserve has so far admitted, or than markets are expecting.

“They haven’t done enough yet to prepare people, “ he said, speaking at the World Economic Forum.  

There are mounting worries that the Fed will ultimately be forced to dish out the ‘Volcker’ medicine of the late 1970s. It has already begun to engineer a deliberate and (hopefully) controlled crash in equity and asset prices.

“I don’t think the Fed believes its own forecasts or inflation models any more, they have been so badly burned,” said Mr Furman.  

The prevailing view in elite policy circles is that if the Fed fails to lance the boil now, the punishment will be even more painful and destructive later.

“It reminds me of Argentina,” said Harvard professor Ricardo Hausmann, a veteran of Latin American crises, describing the Fed’s endless series of excuses last year, even as the economy was flooded with money and inflation was clearly building up. 

“There is just too much stimulus in the pipeline and they are going to have to act much more forcibly. I lose sleep thinking the Fed is way behind the curve,” he said.

Mr Furman said that inflation is being driven first and foremost by excess demand and liquidity in the economy, rather than by supply chain disruptions or higher energy prices, as the Fed argued fervently until late last year. The institution has badly misjudged the calibration of stimulus. 

It predicted inflation this year of 2.2pc as recently as December, but the figure is already running at a 40-year high of 8.5pc. The Fed staff relied on a New Keynesian Phillips Curve model that omits most of the key ingredients in price shocks and is “incapable of predicting any inflation,” said Mr Furman.