July 14, 2022

Anyone Paying Attention?

Having skin in the game has always been the best way to gage the value of present and impending risk. I’ve personally been responsible for managing billions of dollars in bonds and stocks over the last 35yrs, most of it was bonds, which require sharp focus on economics, currency and monetary policy. I bring this up because with all the jargon infested narrative claiming expertise, much of it from those with little direct experience and a few with experience, I always pay more attention to the latter. These days the latter is questioning the Fed from the perspective that the current inflationary environment we find ourselves in is 1: not the same as 40yrs ago, and 2: increasing interest rates will have little impact if spending and money printing isn’t addressed with fiscal discipline. That’s where the government comes in, and that’s where government has failed in at least the last two decades, and these days doesn’t seem to be paying attention. How did we get here?

        In the early 1980’s the economy had become more disposed to inflation, for reasons unrelated to monetary policy. During the period preceding the rise in inflation, any aggressive actions on the part of the Fed Chairman that may slow the economy was not politically advantageous. I bring this up because after Fed Chairman Paul Volker, against all predecessors, crushed inflation by raising interest rates to historic highs, he entered the economy into a severe recession. From that time during the period from the mid 1980’s to 2022, the GDP Implicit Price Deflator measure saw the lowest inflation averaging around 3.0% on an annual basis. That came at the expense of near zero interest rates and the historical printing of money (M2), all occurring during the super growth of technology, capping the half century transition to a service economy from an industrial economy. All of this fueled consumer spending, government and corporate debt growth and a weak dollar. All good for economic growth, but also all inevitably inflationary. So now, Fed Chairman Powell needs to convince the capital markets that he is in control. 

      So, what else is happening? This week both the Consumer Price Index (CPI) and Producer Price Index (PPI) showed inflation through June at 9.1% and 11.3% respectively. This week’s decline in in the broad Indexes of nearly 4% also strongly suggest in anticipation an interest rate increase of 1% at the next Fed meeting (07/27), the highest since 1994. But from an economic point of view last week saw data from June such as the ISM Manufacturing Index decline to 53.0 and the ISM Non-Manufacturing Index declined to 54.0, in each case a move below or above 50 signals economic contraction or expansion respectively. Tomorrow the Retail data is expected to rise with Friday’s Employment data showing wages rose 1.4% over the last three months, more money in the consumer’s pocket. Next week’s Housing data is expected to show negative effects of the recent mortgage rate increases and slowdown in new purchases. 

      Inflation is real, and so too should the Federal Reserve Board be real. But one piece of data that got attention this week is the ongoing inversion of the yield curve (the 10yr treasury 2.97% minus the 2yr treasury 3.0%). In my opinion an inversion is a good thing, because if we really enter a recession in the near term, the Fed would have to stop raising rates, and inflation would certainly take a hit. As long as the government doesn’t engage in its usual mischief. Luckily the 2.4 trillion dollar Build Back Better bill has so far failed reconciliation and probably would’ve made energy inflation even stronger and also give away too much newly printed money, another reckless increase in the budget deficit. But for now, Congress is doing nothing with the exception of investigating the Jan 6 riot, and Powell appears hesitant even as other members of the Fed voting board are making far more aggressive statements, in my opinion, to get Mr. Powell’s attention. Whether or not it works is key to ending the inflation dilemma. In the meantime, waiting out the markets need for certainty requires patience and focus, diversification has kept portfolios less volatile, and cash remains ample for value, when it shows up.


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