The U.S. and euro area inflation rates are high and accelerating, leaving no room for complacent and implausible forecasts of temporary and reversible price pressures.

The U.S. Federal Reserve has come around to the view that the annual consumer price increase of 6.2% last October (4.6% corrected for food and energy prices) is taking place in an economy operating very much above its noninflationary potential of 1.8%. That is also shown in the Fed’s own business surveys (aka “the beige book”), and in similar reports of purchasing agents.

As a result, the Fed is announcing the beginning of a credit tightening process – although there is still no evidence of actual policy moves. Predictably, a more politically colored view of inflation from the U.S. Treasury seeks to mollify the Fed’s stance by emphasizing dangers for economic growth presented by new Covid-19 variants.

The Fed’s view is to be taken more seriously, because it is underpinned by solid evidence of the economy’s main drivers.

Rising household incomes have pushed the private savings rate to 9.6%, and a strong labor demand has reduced the jobless rate in November to its historical lows of 4.2%.

The Fed will have to raise interest rates

There is plenty of firepower there. Jobs and incomes drive three-quarters of the U.S. economy: Household consumption and residential investments are currently growing at annual rates of 5% and 12% respectively.

Optimism inspired by those numbers is moving businesses to invest in new machinery and bigger factory floors to meet expected sales increases. In the first nine months of this year, business capital outlays rose at a strong annual rate of 8%.

The Fed, therefore, has good reasons to begin moving toward a restrictive credit stance.

By contrast, the European Central Bank (ECB) still maintains that the euro area inflation – accelerating to 4.9% in November (from a deflation of -0.3% a year earlier) -- is reversible because it sees energy prices (surging 27.4% last month) coming down in the months ahead.

Financial markets, however, have made up their minds. They expect inflation to remain a major policy concern in the U.S. and in Europe, and they know that a growth recession is the only way to get back to price stability. Over the last month, the Dow Jones and the Euro Stoxx 50 are down 5% and 11.3% respectively (in $ terms).

Getting back into the markets after such a “correction” would still be a risky decision – even if you believe that the Fed will continue to pump up the liquidity (i.e., if you believe in an unconditional “Fed put”), despite high and rising inflation, and that the ECB will maintain its implausible view of declining cost and price pressures.

But that is only part of the problem.

We are now entering a period where a low-polling Biden Administration (the president’s latest approval rating is 49%) faces the possibility of losing its Congressional majority in next November’s mid-term elections.

Biden can’t benefit from hostilities with Russia and China

Such an outcome would open the way for an even bigger problem: A Republican control of the legislative process – and a significant boost to Trump’s presidential contest.

To top it all off, the White House is unnecessarily looking for trouble with Russia and China, while the control of Iran’s access to nuclear weapons is bogged down in a blind alley.

What could – and should – the Biden Administration do?

First, they should get the Fed and the Treasury on the same page regarding inflation and encourage their less hawkish monetary policy statements.

Second, more should be done for the Democratic Party’s unity, and a return to mainstream views of American society. That would reassure the public that new factions would not push the party toward revisions of American values, history and culture.

Third, the White House should resist the view that an exit from those domestic problems should be sought in pushing hostilities with Russia and China to the edge of a nuclear holocaust.

Sadly, however, we are there already. Moscow recently reported a rehearsal of a U.S. nuclear attack on Russia, with American strategic bombers flying within 20 km of Russian borders.

Apart from that, media stories are whipped up about an imminent Russian attack on Ukraine, and China’s similar move against its own province of Taiwan. U.S. analysts most probably know that neither country has any interest in doing that. But demonizing Russia and China is a classical way of diverting public’s attention from pressing domestic problems.

That is a reckless game that won’t do anything for shoring up Biden’s poll ratings and for the political standing of the Democratic Party.

What does all that mean for the U.S. economy and its asset markets?

Markets are justifiably worried about the U.S. economic management and the outcome of Congressional and presidential contests in 2022 and 2024. Unnecessary military confrontations with Russia and China offer no way out from those domestic concerns.