We all indulge in wishful thinking. We can’t see the future so we hope it works out the way we want.
It’s dangerous to our portfolio to indulge in wishful thinking.
Some economic writers are so consistent that they are predictable. John Hussman is predictably bearish (but he has reams of data to back up his ideas). Paul Krugman errs on the optimistic side, as when he joined “Team Transitory” about inflation in 2021. He presents data in his latest opinion which is ambiguous and contradictory. “My guess about what’s really happening is that the economy is indeed slowing, but probably not into a recession, at least so far. And a moderate slowdown is actually what we want to see.”
**Beware Wishful Thinking About Inflation and Recession**
**So long as underlying inflation is high, the Federal Reserve is not your friend**
**By Greg Ip, The Wall Street Journal, July 13, 2022**
**Odds are overall inflation will decline over the coming year as gasoline prices stabilize or drop and improved supply chains temper goods prices. But the question isn’t whether inflation will drop below 9%, but where it settles once various supply shocks dissipate, i.e. what is the underlying trend rate of inflation? No single measure captures that trend but a decent approximation comes from the Dallas Fed’s trimmed-mean personal consumption inflation index, which each month excludes the most volatile prices. It was 4% in May, double the Fed’s target...**
**Underlying inflation is far above 2% and if it takes a recession to get it back down, that is unfortunate, but not an error. In options-speak, the Fed put is deeply out of the money. ...**
**Is monetary policy actually tight, in an absolute sense? One measure of that is the real interest rate, i.e. the nominal rate minus inflation. That, however, depends on what inflation will be. You could once assume 2%, in which case today’s bond yields are positive, though still historically low, and maybe the Fed is nearly done. But if future inflation is 4%, real bond yields are still negative and the Fed has work to do...** [end quote]
The Fed needs to raise interest rates until the real rate is at least zero and preferably positive to be restrictive (as they said they need to do).
Real rates are deeply negative at this time. Nobody knows what the long-term future inflation rate will be. As long as inflation keeps rising the Fed will have to tighten.
That’s not wishful thinking. It’s what they said they would have to do.