by Franklin J. Parker, CFA
The Summary
- The Fed has indicated that it will likely begin slowing their money-printing program as soon as November, and they expect to be completely done printing money by “around the middle of next year.” That would mean the Fed would likely print about $13 billion less per month until July (so, $107 billion in November, then $94 billion in December, etc). This announcement gives investors something to plan on, which is helpful, but it was the more aggressive pace of rate hikes that spooked investors. With inflation stubbornly high and employment still recovering, the Fed is caught between its two mandates. It is a tightrope to walk, and the consequences of getting it wrong are severe.
- Speaking of the Fed, Boston Fed President Eric Rosengren and Dallas Fed President Robert Kaplan both resigned after their annual financial disclosures showed that they had each traded stocks and mutual funds quite profitably through 2020. It was clear from the pattern of trading that they were informed by their position within the Fed, as several trades occurred just days before major policy announcements that moved markets. While this would normally be just another instance of political insiders using their position for personal gain, given the outsized role of the Fed, and the influence of both Rosengren and Kaplan within the institution, this event is notable for investors. The exit of these two is likely to shift the dynamic of the Fed’s policy discussions.
- As I mentioned last week, I see current volatility as relatively short-lived (likely 3-4 weeks), though we may see a pullback of 8%-10% from the recent high in the S&P 500. This marks a great entry point for investors with cash, and is not a big enough deal to justify selling out of highly-appreciated stock positions. In short, my view is that investors who are in should stay in and investors who are out should use this pullback to get in. There is, of course, a risk that this selloff develops into something more significant. I will be watching closely for signals that that is the case, and position portfolios accordingly.
The Details
Inflation is again on everyone’s mind.
Whether high inflation readings are the result of monetary policy—and thus under the control of the Fed—or whether they are driven by supply constraints is central to the debate. How investors answer that question will determine portfolio allocations, so this is a central questions that must be wrestled with.
The Fed has maintained that high inflation figures are from supply constraints caused by COVID and other supply-chain disruptions. Others have insisted that easy monetary policy (i.e. low interest rates and money printing) are to blame.
I have a more nuanced view.
In a normal recession recovery, employment is the last to recover. That leaves many people with less cash than they had in the expansion, and so the demand for goods and services is rather slack. Once the economy reaches full employment, demand again increases and price inflation begins to manifest.
Employment has behaved similarly in this recovery as in past ones (though it has recovered faster than in previous recessions). However, unlike in past recoveries, extended unemployment benefits and numerous rounds of stimulus has given people substantially more buying power than they would otherwise have. This excess buying power has yielded much higher demand for goods and services than we would normally have. Given that there are more job openings than unemployed persons, this indicates that production and demand are significantly mismatched in our economy.
Of course, while not specifically driven by monetary policy, these extra benefits have been paid with newly-printed money from the Federal Reserve.
Current inflation, then, is caused by both monetary policy and ongoing supply constraints.
For investors, this means that the amount of inflation we can expect to fade is the part driven by supply constraints. This is okay news—not great and not bad. Inflation should abate somewhat, and the Fed’s tightening schedule may serve to reign in some of the monetary portion of the problem. Of course, the Fed’s tightening schedule will also serve to slow economic growth, as well. There is a tug of war at play.
As I have said many times before, the most important attribute for investors right now is flexibility. We must take this one data point at a time and be willing to make portfolio adjustments based on new data, especially inflation.
Chart of the Week
This week’s chart comes from the Wall Street Journal, and demonstrates the percentage of items that have seen price increases. As the chart shows, we are seeing the highest number of items with price increases since 2009. Much higher and this would put us back into the 1980s, a period characterized by higher-than-desired inflation. In the end, this is worth keeping a close eye on.
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