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Iron Capital Insights

  • Iron Capital Insights
  • September 1, 2022
  • Chuck Osborne


College football kicks off this Labor Day weekend. Most of the top teams will have an easy time of it, but there are bound to be some first-week upsets. The upset will, of course, be accompanied by the underdog’s fans chanting, “Overrated…overrated…!”

Have you ever given that any thought? It really doesn’t make much sense, does it? They might as well be saying, “You’re as bad as we are!” How about actually giving your team some credit? Maybe the favorite wasn’t overrated; maybe your team is just that good. Nah, they were overrated.

Football teams are not the only ones who get overrated. In my opinion, the Federal Reserve is hugely overrated. I will be the first to admit that my belief is not the mainstream. I am in a minority here, but I’m okay with that. I also want to be clear, because we live in a world of absolutes: one must be on one side or the other. An idea is either brilliant or evil, there is no middle ground. (That is nonsense; there is always a middle ground, and usually that is where the truth is found.) When I say the Fed is overrated, I am not saying the Fed is without influence.

The Fed has plenty of influence. However, its ability to impact the actual economy is greatly overstated in my opinion. I have a hard time believing that there was an enormous amount of economic activity that will no longer take place because the Fed has raised interest rates by 2.25 percent. Even if rates get as high as 4 percent for the overnight Fed funds rate, that is still lower than it was for much of the 1990s when the Fed was fueling the tech bubble with “low” rates.

© Nuthawut Somsuk

If the Fed raised rates dramatically as it did in the 1970s and early 1980s when rates peaked at more than 20 percent, then it could cause a severe recession, but that isn’t likely to happen. I believe that the Fed has to move rates dramatically before having an impact on the real economy. It does, however, have enormous influence in financial markets, especially the bond market. In the bond market, a small move in rates equals a big move in the value of bonds. Add to that phenomenon the fact that the Fed basically became the bond market during the financial crisis in 2008 with “quantitative easing” – the actual purchase of government bonds. The easing went on much longer than needed (if needed at all), and the Fed now has an enormous bond portfolio it is in the process of liquidating. No one really knows what the impact of that move will be. Quantitative easing was new ground, and now we get to see what quantitative tightening does.

My guess is that it will have little impact on any of our daily lives, but the market is convinced that it is going to cause a recession. (Of course, we are technically in a recession, but no one wants to admit it.) Some have clarified that the Fed will cause an “earnings recession,” meaning corporate earnings will go down. The issue I have with that theory is that the underlying cause of all of this is inflation. Inflation does not impact all companies the same; some are hurt, but most actually will see earnings rise. The rise is only nominal – the higher earnings from price increases get eaten up in the next period by higher costs, all due to inflation – but nominal earnings is what companies report.

We believe the market is giving too much credit to the Fed and is overstating the threat of a severe recession. The JOLTS job openings were reported earlier this week and there are basically two open jobs for every unemployed person in the U.S. This is after the Fed has raised rates.

This is the problem in the market now: Fed action isn’t causing the real economy to slow dramatically, as the market fears. Every time we get data confirming this, the market, instead of celebrating good news, fears for even more Fed action, which it believes will cause real harm. At some point, good news has to be accepted as good news.

As we have written before, the Fed did not get us into this situation alone, and it cannot get us out of it alone. Meanwhile, one cannot fight the market. We remain defensively positioned, but also cautiously optimistic. At this point, this still could be just a dip in the rally. We will know shortly which way we will go. We hope for the best but stay prepared for the worst.

Warm regards,

Chuck Osborne, CFA
Managing Director