Peter Schiff: Here's When The Fed's Nightmare Becomes Reality

Last week's inflation data was seen as a positive development, triggering speculation that the Fed may hike rates again as higher inflation is generally seen as a sign of economic growth.

On February 19, data from the Labor Department showed that the core consumer price index (CPI) rose in January at a 2.2 percent annualized rate, the highest in more than 4 years, well past the 2.0 percent benchmark set by the Fed. It was received as welcome news.

But, in reality, it may be the other way around. Peter Schiff in a commentary with Euro Pacific Capital said it is the Fed's "worst possible nightmare."

'Worst Possible Nightmare'

Schiff said, "It will expose the error of their eight-year stimulus experiment and the Fed's impotence in restoring health to an economy that it has turned into a walking zombie addicted to cheap money."

Schiff noted that the economy may be entering a period of "stagflation" in which very low (or even negative) growth is accompanied by rising prices. This creates terrible conditions for consumers whereby prices rise but incomes don't. This leads to diminished living standards.

Just Because Inflation Improves Doesn't Mean Things Get Better

"Just because inflation picks up does not mean that things are getting better. It actually means they are about to get a whole lot worse. Stagflation is in fact THE nightmare scenario for the Fed. If inflation catches fire now, the Fed will be completely incapable of controlling it," he wrote.

Schiff questioned that if a 25 basis point increase in December could affect equities this drastically, think about what a real rate hike would mean. "With growth already close to zero, a monetary shock of 1% or 2% rates could send us into a recession that could end up putting Donald Trump into the White House. The Fed would prefer that fantasy never become reality."

The Worry

According to Schiff, the real nightmare for the Fed is not the extra body blow higher prices will deliver to already bruised consumer, but the knockout punch that will be delivered to its own credibility. The markets believe the Fed has a duel mandate, to promote employment and to maintain price stability.

Schiff added that Fed is currently operating like it has just a single unspoken mandate: to continue to shower markets with easy money until asset prices and incomes rise high enough.

This will reduce the real value of debts to the point where they can actually be serviced with higher rates, regardless of what happens to employment or consumer prices along the way.

"Once markets figure out that the Fed is all hat and no cattle when it comes to fighting inflation, the bottom should drop out of the dollar, consumer price increases could accelerate even faster, and the biggest bubble of them all, the one in U.S. Treasuries may finally be pricked. That is when the Fed's nightmare scenario finally becomes everyone's reality," he concluded.