I have linked to a long article which does Monday morning quarterback analysis of the economy, monetary and fiscal stimulus since 2020. I basically agree with it though I think it may be a little too harsh.
TPTB looked at the very slow recovery from the 2008 financial crisis (“The Great Recession,” which took 12 years for working-age unemployment to recover from its pre-crisis peak). High unemployment for those endless years blighted millions of households and the career prospects of millions of people.
In 2020, recalling the Great Recession’s terrible harms, the Fed decided to quickly implement record monetary stimulus (much faster and larger in 2020 than in 2009). Congress, which did no fiscal stimulus in 2009, decided to implement rapid, huge fiscal stimulus. That put money directly into the hands of consumers during a Covid-driven economic shutdown that could have become a much worse and longer recession than 2009.
As a result of this 2020 stimulus, people’s lives weren’t devastated, the economy quickly recovered and the markets boomed. Unemployment dropped very quickly compared with earlier recessions.
In retrospect, it was bold and effective action that saved the economy and millions of people from disaster.
The monetary and fiscal stimulus were like a huge locomotive rushing along a track. It’s hard to determine exactly when the brakes should be applied. There’s a tremendous amount of momentum. Fed Chair Jerome Powell now says that the Fed should have removed stimulus earlier, in 2021. But there was no way at the time to foresee the impact of supply chain constraints, Russia’s invasion of Ukraine and Covid in China on inflation.
The Fed really believed that inflation would be transient. They didn’t realize that inflation would become entrenched and affect the entire world. Everyone is competing to buy the same products which are still delayed and in short supply.
Anyone who says that the high inflation in the U.S. wasn’t driven by excess fiscal stimulus and points to high inflation overseas as proof doesn’t understand that prices are international and negotiated by the balance of supply and demand. The entire world is affected by constrained supply which is causing inflation everywhere. High stimulus in the U.S. added excess demand to the already lower supply, increasing inflation here more than otherwise would have been the case. This is AND not OR.
But there’s no point arguing about it because the excess stimulus is over and not likely to be repeated. But normalizing demand will not normalize supply. We will have inflation until supply meets demand.
The Fed can’t do anything about supply.
The Fed will try to reduce demand by increasing interest rates, which will slow the economy. They are correctly aiming for a neutral fed funds rate which will neither stimulate nor slow the economy. They should have done this 20 years ago. The Fed’s excess monetary stimulus since 2002 has led to asset market bubbles and busts.
The most valuable part of the article to us, as investors, is the long-term interest rate forecast. The question is: what is a neutral fed funds rate? It’s a moving target since the Fed will readjust continually based on inflation.
**How the Fed and the Biden Administration Got Inflation Wrong**
**Officials applied an old playbook to a new crisis. ‘We fought the last war.’**
**By Nick Timiraos and Jon Hilsenrath, June 13, 2022, The Wall Street Journal**
**Officials have acknowledged that inflation is unlikely to recede quickly. Now they are scrambling to rectify their earlier miscalculations, a process that carries new risks of recession.**
**A year ago, Fed officials were projecting that inflation, using their preferred measure, would recede to 2.1% by the end of this year. They now see it at twice that, and unlikely to return to their 2% target before 2025. They have raised short-term interest rates by three-quarters of a percentage point and are on track to raise them another half-point at their meeting this week. The Fed is likely to keep raising rates at least at that pace for their next several meetings, the most rapid adjustment in decades....**
**Private forecasters surveyed by The Wall Street Journal projected inflation will be 4.8% by the end of 2022....** [end quote]
But what do they know? They were “Team Transient” just a few months ago.
“Several Fed meetings.” To me, a “couple” is two. A “few” is 3 or 4. “Several” is 5 to 10. “Many” is more than 10 – but maybe that’s only because I have 10 fingers.
I don’t think the Fed will raise the fed funds rate by 0.75% on Wednesday because the market is expecting 0.5% and there’s no point upsetting traders for a trivial 0.25%. But the Fed can keep tightening and tightening and tightening until inflation responds. Till 2023 and beyond. Plus increasing longer-term rates (e.g. mortgage rates) by selling their long-term Treasury and mortgage bonds.
The season truly is moving into winter. There may be a few sunny, warm days in the asset markets but don’t expect spring for a long time to come. Maybe months if supply chains improve and inflation comes down. Maybe years if inflation becomes entrenched and Powell decides he needs to channel Paul Volcker.