Recent comment by Fed Vice Chair Donald Kohn:

If longer-term inflation expectations were to become unmoored–whether because of a protracted period of elevated headline inflation or because the public misinterpreted the recent substantial policy easing as suggesting that monetary policy makers had a greater tolerance for inflation than previously thought–then I believe that we would be facing a more serious situation.

This could be telling. It hasn’t been said before by any FOMC member, and it was voluntary, in that no one asked the question.

It is something he is trying to communicate.

The FOMC sees inflation expectations showing signs of elevating, and is wondering whether it is at least partially responsible.

Their ‘theory’ had told them there was an inflation price to pay for cutting into a triple negative supply shock if it went so far as to allow inflation expectations to accelerate.

Credit spreads are in substantially from the wides, GDP isn’t collapsing and forecasts are for modest improvements.

Fiscal rebates are kicking in, being spent, and supporting prices.

Inflation is ripping, and now has the full attention of the FOMC.

Oil 130+

Dollar down

Stocks down a touch

Interest rates up a touch

My expectations for moderating inflation and limited spillover effects from commodity price increases depend critically on the continued stability of inflation expectations.

The FOMC has never wavered on this all important aspect of monetary policy – they firmly believe inflation expectations are what causes a relative value story to turn into an inflation story.

In that regard, year-ahead inflation expectations of households have increased this year in response to the jump in headline inflation. Of greater concern, some measures of longer-term inflation expectations appear to have edged up. If longer-term inflation expectations were to become unmoored–whether because of a protracted period of elevated headline inflation or because the public misinterpreted the recent substantial policy easing as suggesting that monetary policy makers had a greater tolerance for inflation than previously thought–then I believe that we would be facing a more serious situation.

If inflation expectations come unmoored for any reason, inflation is thought to follow.

And here he expresses concern that inflation expectations may be rising due to a public perception that the Fed easings mean the Fed has a greater inflation tolerance.

Governor Kohn is clearly concerned that the Fed’s actions since August may be causing inflation expectations to elevate, and his statement further implies that it will take actual ‘action’ on the part of the Fed to dispel the notion that they are more tolerant of inflation.

Markets will not believe the Fed will take action on inflation until after they actually do it, but that the Fed will respond to weakness regardless of inflation. This was expressed by today’s price action. With crude hitting $129 EDs a year out are 8 bps lower in yield.