Everything is getting expensive.
Your milk is $2 more expensive. The gas prices are harboring close to $4.10/gallon. Wait… when did the price of cucumbers go to $3 a pound?
I am getting a lot of messages from members who cannot comprehend that inflation is climbing higher and higher.
“It doesn’t make any sense!”
Frequently the market does not make any sense. For long periods of time. In this weeks issue, we’ll explore inflation’s continuing climb higher, and how the Federal Reserve isn’t doing anything about it. And it won’t, until it is too late.
The post-pandemic economy has already arrived
With the recession having officially ended in April 2020, we’re now 16 months into the recovery — and the contours of the post-pandemic economy have taken shape.
Worth noting: The economy is bigger now than it was before the pandemic, officially recovering from its pandemic-induced crash.
Why it matters: While the coronavirus continues to infect 100,000 new Americans every week, it’s no longer driving the course of the economy.
- The Delta variant shows no signs of slowing growth in GDP or consumer spending, both of which are already above their pre-pandemic levels.
- Corporate earnings and the stock market are at record highs
- Jobs, however, are a different matter.
Between the lines: Entire industries, like movie theaters, are permanently changed. Studios took advantage of the pandemic to pivot to a subscription-based streaming model — a model that Wall Street has endorsed.
- Being able to stream movies at home on the same day that they’re released in theaters — as Disney recently did with “Black Widow” — is going to be the new normal.
- Lower-paid industries like food service saw an exodus of jobs over the course of the pandemic, and many of those jobs will never come back. Instead, they will be replaced by technology such as ordering from phones instead of servers.
The bottom line: Recovery does not mean reverting to how things were before the pandemic. In fact, it means things are going to get more expensive even faster. Everyone and everything is getting back to a “new normal”.
The big picture: Fiscal policy in the United States has moved on. Emergency pandemic relief is coming to an end; long-term infrastructure investment is now Treasury’s top priority.
I figure we have about 12–18 months before the Fed finally gets serious about inflation — which will happen when the Consumer Price Index (CPI) is around 10 percent.
The Power of Numbers: I recently needed to purchase paper. At Office Depot, the regular paper stack was $11. Last year it was $9. Multiply this trend with every good in the Consumer Price Index (Inflation Gauge). 😐
The Biden administration is trying to deny the existence of inflation, tweeting that the cost of a 4th of July barbecue declined 16 cents year over year. There’s a level of spin I can’t possibly imagine, and I voted for Biden.
If nothing else, Powell is his own man.
He resisted the call for lower interest rates and negative rates, up until the period of COVID when it was “appropriate”. The Fed is clearly data dependent. Powell can look at the data and change his mind, but right now markets want firm leadership and a clear path forward. Their is a proper correlation between the Fed’s alphabet-soup of emergency programs and the reason why short-term real rates are in the -5% area. Even 30-year Treasury-bonds are almost -.3%. Commercial lending rates aren’t quite as low, but in real terms are still zero or negative for top credit risks.
Key Takeaways
- Negative interest rates mean that borrowers are paid interest instead of paying interest to lenders.
- With negative interest rates, central banks charge commercial banks on reserves in an effort to incentivize them to spend rather than hoard cash positions. This can cause banks, investors, and firms to spend money quickly, usually not on operations and training, but in ways to increase their market value. (Bubble)
- With negative interest rates, commercial banks are charged interest to keep cash with a nation’s central bank, rather than receiving interest. Theoretically, this dynamic should trickle down to consumers and businesses, but commercial banks have been reluctant to pass negative rates onto their customers.
Jerome Powell is making that same bet. The conditions causing the inflation we see today, 5.4% inflation as of two weeks ago and 6.2% for the last four months, are different. (PCE inflation, which the Fed uses, is up 4% year over year.) All of this, built on subjective models, which shows inflation as transitory.
Powell does have a point in that much of the inflation we see today is due to COVID-caused supply shocks.
Since COVID is “transitory,” the cause of the inflation was transitory.
Except that wages are sticky, house prices continue to rise as they buy $40 billion a month of mortgage-backed securities keeping mortgage rates low, semiconductor experts expect a shortfall for at least two more years, and I could go on and on.
With rates at zero and QE at an extraordinarily aggressive pace, they are doing the opposite of leaning into the inflation pulse that is quickening in the United States. And they are literally showing no concern, at least not in a policy change between now and the end of the year. They are talking about it while still adding fuel to the fire.
Perhaps Powell is right. Perhaps inflation will be transitory. But the longer they maintain this massively easy monetary policy, it will lengthen the time that uncomfortably high inflation is “transitory.”
Fed officials believe the economy is still very fragile, and that if they began to even modestly normalize monetary policy, it runs the risk of pushing the economy into a more fragile condition. The stimulus money is going to run out soon. Eviction notices will start coming out in December (unless the moratorium is somehow extended, but then how does that help a severely impacted real estate industry?).
Until we know how the economy is going to react to those events, changing policy today is very risky, at least in their eyes.
