“The difficulty lies not so much in developing new ideas as in escaping from old ones.” ~ John Maynard Keynes
Federal Reserve Chairman Jerome Powell assured us last spring that inflation was transitory. At the time, we suggested that perhaps transitory didn’t mean what he thought it meant. Now he is telling us that inflation must be crushed through pain. He was wrong then, and he is wrong now.
It is as if Mr. Powell, his fellow Fed governors, and the approximately 400 doctorates who work for the Federal Reserve are all fit with blinders. They didn’t see the growth in money supply, or the high energy and food prices, or the incredible increase in housing cost. They could only see short-term supply issues caused solely by our reaction to the COVID pandemic. Those were temporary; therefore, inflation was transitory. They were blind to all the more lasting drivers of inflation, and as a result, they were late in addressing it.
They finally did address it, however, and have now raised rates from 0.25 percent at the beginning of 2022 to 3.25 percent. That is a substantial increase in a short period of time. The impacts of these raises have not even had time to work their way into the economy. Meanwhile, the drivers of inflation that the Fed missed on the way up, are now all on the way down. Money supply, energy prices, and housing are all in declines. The price of oil went below $80 a barrel on Friday for the first time since January. They were blind on the way up and now they are blind on the way down.
They seem to have it stuck in their heads that the only way to beat inflation is to cause a recession. Guess what? We are already in a recession. We have had negative GDP growth for two quarters in a row. The Fed is predicting the GDP growth for 2022 will be 0.2. To achieve that, we would have to grow the second half of this year at a rate of more than 2 percent. Based on where we are now and in light of the Fed’s actions, that is so overly optimistic it is laughable.
Powell, and many other pundits, keep saying we are not in a recession because the labor market is still strong. I understand that; the labor market has long been our indicator as well. It was weakness in the labor market that made us predict a bear market in 2008, although we had no idea it would be as bad as it was. However, it isn’t always the same. We have had two quarters in a row of negative growth; that is a recession. Inflation is coming down; there is no need to make things worse.
If you have not seen it, I would recommend watching the CNBC interview with Jeremy Siegal[1]. Mr. Siegal, economist and professor of finance at the Wharton School, sums up the frustration we all have with the Fed.
Unfortunately, the Fed that was blindly focused on pandemic supply issues seems now to be blindly focused on employment and wages. They believe that they cannot truly cure inflation unless they drive unemployment up and wage growth down. This is an old idea, and in fairness it has some merit. However, there are new factors that they seem to miss: Although unemployment is low at 3.7 percent, we still have a full 1 percent decline in the labor market participation rate from pre-pandemic. If that 1 percent were to rejoin the labor market tomorrow, then unemployment would be 4.7 percent – three tenths of a percent higher than the Fed’s target of 4.4 percent. We have a worker supply problem, not a job demand problem.
Their other focus is on wages. Wages are rising, but that is not driving inflation, it is lagging behind inflation. Real wages are and have been dropping. You don’t need me to tell you that – every person we talk to is talking about budgets being strained, not wallets being flush.
If I had any hair, I would be pulling it out. But, we must play the hand we are delt. We are making moves to position portfolios as best we can. The silver lining of higher interest rates is that bonds are beginning to look attractive once more (and I did have hair the last time I could honestly say that). If Powell gets his wish and our current mild recession becomes a more severe recession with global implications, investors will look for quality, and most of that is here in the U.S.
It has been a rough year mostly due to poor policy, and it may now get worse due to even more poor policy, but it will pass. It will indeed be morning again in America at some point. Bear markets create opportunities for long-term investors. We will get through this.
Warm regards,
Chuck Osborne, CFA
Managing Director
[1] This video is available via CNBC Pro with a 7-day free trial. As an alternative, Mr. Siegel reiterates the same position in this clip from “Squawk Box” 09/26/22
