(Photo by Win McNamee / Getty Images)
When Fed chairman Powell spoke to the public at the virtual conference in Jackson Hole, I wondered if he might admit that the Fed had grossly underestimated inflation and that he now saw the need to address the “emergency.” “To reduce the pressure of money. The market should hear this as it was prepositioned as a short US dollar, long government bond, and disinterest in gold. While the vast majority in the latest Bank of America Money Manager poll think inflation is temporary, inflation is there and is a fact. Using a 3-month annual rate (to eliminate base effects), the Fed’s most popular inflation measure – Core PCE – is at a nearly 40-year high of 6.7%. Instead, Powell, who never saw this level of inflation coming, selectively congratulated the Fed on meeting its never-specified inflation target and pushed for zero interest rates and $ 120 billion in “emergency” money printing to discuss reducing this year. This is becoming an increasingly dangerous game for financial markets and the economy.
Inflation is the most dangerous, cowardly and stealthy way of dealing with our massive debts and unsecured liabilities. It is a figurehead for the term “politically expedient”. Is this the best way for the custodians of the value of our currency to deal with the uncontrolled, never-surprising fiscal spending of Congress and a debt-laden economy where debt is close to 400% of GDP (as opposed to 150% of GDP in 1965 when? the “great inflation” began). As Keynes said: “Through a continuous process of inflation, the government can secretly and unobservedly seize an important part of the wealth of its citizens”. And, as is currently the case, it hits those who are least able to handle it: the poor, the elderly and the poor. When it comes to financial markets, Milton Friedman put it best: “Inflation is like alcoholism. The good effects come first ”. We are now in the markets. We are in a tear in the stock market, believing that this beneficial inflation is being controlled and growing positively as far as the eye can see. There is little concern about the burgeoning labor imbalance or potential margin compression due to skyrocketing commodity prices. More on these risks later.
To say it’s Powell’s “game” means that of course he knows these things, but plays the strategy anyway. For those who disagree, let me ask you a few important questions:
1. In the Jackson Hole speech, Powell used the word “temporary” again to describe inflation. As calculated by Bianco Research, these transient proportions of core PCE inflation are approximately 7% of the index. These include rental cars, airline tickets, and hotel prices. You have probably peaked. But why didn’t Powell mention or discuss the 40% of the index that consists of housing / lodging / rent? Surely he has read his own Fed polls that show that this trend is much higher?
2. Why does the Fed insist on buying more than all of the TIP market issues? TIPs are an obscure market tool used by the Fed that is a key measure of future inflation expectations. In fact, since this round of money printing began (3/20), the Fed has bought over $ 210 billion in TIPs while the government has only spent $ 60 billion. Could this be an attempt to dampen one of the key measures of future inflation expectations? We could ask Vice-Chair Clarida, an expert on inflation expectations, but he appears to be on witness protection until the end of his term in January.
3. Powell’s term as Chairman ends in February and he wishes to be reappointed. Is he following the advice of the Hues Corporation in 1974: “Don’t rock the boat, baby, don’t you tip the boat over?”
4. Have we recently seen a large committee of government “experts” become increasingly political and then ignore, reject, and dissolve until it finally ends in disaster, obvious signs that the strategy is seriously flawed? (Hint: starts with A and ends with N).
How do we know this inflation is getting out of hand? Phase one is already taking place. Several members of the Fed have raised concerns about inflation, including former Boston dove Rosengren. Not all of them are voters this year, and none of them are Powell, Clarida, or Williams (NY Fed). Fortunately, four of the questioners will become voting members in January. I assume that long before that we will be trading in the three markets that are macro pressure relief valves: government bonds, dollars and gold. Watch them all because, to paraphrase Tolstoy, “everyone is flawed in his own way”. Government bonds, which will not stay at 1.3% if inflation stays above 4%, are in the Fed’s hovering campaign and they have bought virtually all government bond issues in the last year. In addition, US Treasuries compete worldwide with yield-free Bunds and Japanese bonds. The dollar trades in a world of almost equally wasteful developed nations and still Covid-ridden developing countries. And gold is fighting an ever-new war with Bitcoin for the champion of alternative currencies. However, if the markets sense that the Fed is losing to inflation and not act urgently, those markets will all move in their historically predictable ways: bonds and the dollar go down and gold go up.
I’ll close with the current GOAT, the US stock market. I see enormous risks there too. Consider 1965, the start of the great inflation, as an analogy: A compound valuation metric developed by Ned Davis Research uses dividends, cash flow, revenue, and CPI-adjusted price-earnings-price to value the S&P 500. In 1965 it was 20-25% overvalued and in 1974 it was 50-55% cheap; Inflation created a terrible decade for stocks. This metric overrated the S & P500 by 100-120% today. Using Warren Buffet’s preferred valuation tool, the S & P500 was valued at 70% of nominal US GDP in 1964, and after Nixon’s resignation in 1973 that figure had dropped to 35%. Today we are trading at 204% of GDP. The same message: we risk managers should be concerned.
For now, I leave you with the immortal words of Will Rogers: “Invest in inflation. It’s the only thing that goes up ”.