Monday, June 14, 2021

Inflation: The Endgame Approaches

(NOTE:  Today's market update can be found at this link)

The latest inflation data shows core CPI over the past three months has increased at a 5.2% annualized pace, which is the fastest since 1991.   The Fed is expecting this to cool down, since they believe some of the inflation is due to supply-chain bottlenecks and such, along with sudden demand-side increases caused by the economy reopening.  There may be at least some validity to that line of thinking.  However, surely that's not the entire story, and the question remains regarding how much of current inflation is due to real-world market factors vs. how much is due to the printing press (both in terms of QE and in terms of the massive "Covid stimulus" (with an added "ahem," for anyone who ever delved into those numbers -- suffice to say the spending went far beyond the obligatory checks the working class received.). 

It's worth noting that the Fed's "target" inflation rate is 2%, and in order to meet that, prices would not only need to stop rising, but would actually have to turn around and decrease for the rest of the year.  That seems incredibly unlikely.

Nevertheless, I doubt the Fed will entertain raising rates before 2021 is in the rearview mirror (at least, not at this meeting -- if inflation hits 10% before the next meeting, then who knows), as they will probably want to take a "wait and see" approach and observe how the market equilibrates after the initial shocks of reopening.

But it would seem that raising rates at some point in 2022 or 2023 is becoming inevitable.  JP Morgan is expecting "late 2023" for rate increases, but I'd be surprised if the Fed can hold out for a full two-and-a-half years -- however, maybe I'm just being pessimistic, given that the first step (before raising rates) will be to taper QE, and given the Fed's "new policy," under which they will allow inflation to overheat for a bit to "average out" against the years it remained below 2%.  If inflation doesn't get too much worse, then maybe they will indeed let it run unchecked into the end of 2023.

Of course, that's going to be a sharp stick in the eye for the working class, who loses purchasing power at the rate of current inflation, not at the Fed's on-paper hypothetical "average."  For working Americans, 5.2% yearly inflation is exactly the same as a 5.2% yearly pay cut.  How many people might be willing to give back those one-off stimulus checks for a 5% raise for life?  Most, I'm guessing.  If there were any truth in advertising, then instead of "stimulus," they should have called it "The World's Most Expensive Payday Loan."

Ain't no such thing as a free lunch.

On June 1 (prior to the most recent inflation data becoming public), Fed governor Lael Brainard said: “Should inflation move materially and persistently above 2 percent, we have the tools and experience to gently guide inflation back down to target. And no one should doubt our commitment to do so,”

I, for one, have no doubt about the Fed's "commitment."  What I question is their competence.  Their "experience" resume doesn't exactly point to a stellar track record in this arena.  Additionally, this is where things will almost-certainly start to get hairy.  This is, in fact, the first time the Fed has faced significant inflation since the launch of Quantitative Easing in 2009.  In the interim years, the Fed has had the luxury of seemingly-infinite "no-consequence" money-printing, as inflation remained tame.  This allowed the Fed to keep rates low and pump as much QE as they wanted, with the only apparent consequence being a rising stock market.  Hardly a tough road.

But those days of wine and roses are almost certainly nearing their end.  And just like in the movie of the same name, the market has become addicted to the cheap rush of Fed printing.  How will it react when forced into the throes of withdrawal?

How will the market react when it comes time to attempt to pay for all the lockdowns and "stimulus" spending (and Lord knows what else by then), but there's no QE available to soak up supply at Treasury auctions?

There's talk of raising taxes, but raising taxes tends to stifle the economy and, as a result, can actually lead to decreased revenue -- this can happen when it ends up being a bigger piece (higher taxes) of a smaller pie (a contracting economy).  Which thus hurts your citizens in every way possible, while not helping the government's fiscal problems in the slightest.  So raising taxes is far from being an "automatic" solution, and may not end up being a solution at all.  It could, in fact, end up creating more problems than it purports to solve.

These are a few of the questions our vaunted leaders have been ignoring.  For a long time.

Conversely, these are the questions bears have been asking for a long time.  They may be getting close to finally getting their answer, as we're starting to get a glimpse of the real-world endgame.  

And, while it may still be a little ways off, it doesn't look pretty.

Trade safe.


  1. Housing, used cars, Oil, most commodities isn't a transitory phase. Wait till the whole world emerges from this pandemic. Boggles the mind how fast and high inflation will go. Bubble already. Equities according to buffets 7 indices. Not just high but made all time highs. FED can buy all bonds, increase QE to infinity and will not stop REAL inflation from destroying all they hoped to gain. In 1929 the new paradigm was formed and accepted. This is as close to Tulip mania as I have ever witnessed. ONLY question is when does the carnage start.

  2. How bad is the next drop going to be? Bloomberg article describes housing bubble worse than 2008. record low rates, fiscal stimulus, lockdown savings, limited housing. We are living in INSANE TIMES as our democracy has already imploded & hedonistic selfishness guarantees a dark future. I am as sure of this as i was last year that a pandemic would cause a big drop in stocks.