September 2022 Macro Commentary - Investing in Hope
(3-minute read)
Investors have a long history of incorrectly assuring themselves that certain inescapable realities won't occur. The rise in interest rates and endemic inflation are two of those realities.
QT is now the Fed's mission yet controlling our inflationary environment will be difficult unless this QT moves more aggressively. Those are inescapable realities.
Cheap exports from China and Russia are in decline, and rolling COVID lockdowns, quarantines, and mass testing in China will lead to hyper-demand when those restrictions are eventually loosened.
Russian weaponizing its Nord Stream 1 pipeline under false pretenses will soon find the peak inflationists expunging their past LinkedIn missives. Gas prices will again approach $5/gallon by winter despite the still functioning Soviet-era pipelines and the South Stream pipeline through Turkey. So far, the Western sanctions war is not going as well as expected, and Moscow is holding a full house while the West is bluffing with a pair of twos.
What happens in China and Russia is closely linked to what happens to our own domestic economy – especially when these two dictatorships are aligned in a European invasion.
Recently economists Francesco Bianchi of Johns Hopkins University and Leonardo Melosi from the Chicago Fed released a paper questioning how much monetary policy can do to bring down inflation if the country's fiscal position is deteriorating. The fiscal position of our country is declining; thus, monetary policy can only really work if not done in advertised 75bp increments. That is classic appeasement, not unlike Britain's pre-WW2 policy of "benevolent neutrality" by not favoring one side or another. The latest Fed minutes and regional Fed comments exhibited appeasement that was not really highlighted by the media: "Participants judged that, as the stance of monetary policy tightened further, it likely would become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation," the minutes said." This week, Thomas Barkin, president of the Richmond Fed, told the Financial Times he had a "bias" towards tightening monetary policy quickly "as long as you don't inadvertently break something."
In short, QT is still too light, the Fed is still behind, and thus inflation will not fall below 4% by '24, despite the Fed Funds rate most likely exceeding 4% by mid-2023. Therefore, the sooner the Fed stops being the benevolent appeaser, the rosier the future will look for all of us.
A normalized yield curve by early 2024 might very well look like this:
3.65% 2-year — the long-term average is 3.14%.
4.25% 5-year — the long-term average is 3.73%.
4.75% 10-year — the long-term average is 4.27%
5.5% 30-year — the long-term average is 4.78%
Our economy can easily function for the vast majority of Americans with this higher term structure of interest rates.
Given that the roots of this inflationary surge are historically broad, appeasement may be unconscionable. The looming rise of labor demands is not the least of these long-term inflationary forces. The Fed published its most recent Beige Book (an anecdotal assessment of regional economic conditions), which found evidence of a tight labor market across the country. Undoubtedly, the decades-long decline of private-sector unions came from endemic corruption and their inability to save jobs in our manufacturing sector. Today's emerging labor movements are well aware of that history. Workers have voted to unionize at Chipotle and Trader Joe's for the first time. The first Amazon warehouse and Apple Store voted to unionize, as did the recreation equipment maker REI. In addition, more than 230 Starbucks locations have voted to unionize since last year, triggering tough opposition from the company, which recently was accused by the National Labor Relations Board of illegally withholding critical benefits from union workers. Finally, unions representing 90,000 workers at the nation's freight railroads threatened a strike starting September 16. That could mean a quarter of the nation's freight would stop moving.
And can we fail to also ignore climate change? Look at the recent headlines:
"Europe's Scorching Summer Puts Unexpected Strain on Energy Supply"
NYT 8/18/22
"China's Scorching Heat Leads to Power Cuts, Factory Disruptions"
WSJ 8/18/22
"Brutal heat wave shatters all-time records, threatens power outages across California." CNN 9/7/22
"UK heatwave: London officially declared in drought" BBC News 8/8/22
Global warming destroys food supplies, causes havoc with our energy sources, and thus stokes inflation. Maybe it would be best for the “peak inflationists” to open a book on economic history and see how destructive inflation is on societies as a whole. The Fed should have begun QT 18 months ago instead of continuing to fuel the speculative party in US tech stocks, single-family homes, and cryptocurrencies.
No matter who delivers the message, interest rates will most likely have to rise sharply, or we face years of inflation, recurring liquidity traps, and unaffordable housing. Housing is a place to live, not a tradable security, and protecting cheap money only helps speculators, usurers, and traders.
More importantly, negative real yields threaten our financial and economic systems by transferring wealth from savers to debtors. They punish savers and reward debtors, who essentially get "paid" for borrowing money. This erodes the very foundation of our banking system and financial markets.
The coronavirus pandemic marks the dividing line between the deflationary forces of the last 40 years and the resurgent inflation that could easily ensue for the next five years. Only a normalized yield curve that gives savers real positive returns can shorten that period.
| Yung Lim | Dean Smith | George Lucaci |
|---|---|---|
| Chief Executive Officer | Chief Strategist and Marketing Officer | Global Head of Distribution |
| Chief Investment Officer | RISR Portfolio Manager | |
| ylim@foliobeyond.com | dsmith@foliobeyond.com | glucaci@foliobeyond.com |
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