How the Fed’s plan to let inflation run hot could completely upend the way the market functions
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The Federal Reserve’s plan to let inflation run hot could shake up decades-long regimes in markets and the economy.
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Higher inflation stands to lift cyclical assets and slam Treasurys and high-grade corporate bonds.
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A period of steadily high inflation and strong growth could replace the past decade’s weak expansion.
Regime changes are usually identified years after they first emerge.
LeBron James’ decision to take his talents to South Beach kicked off a new era of NBA “superteams,” assembled by friendly superstars coordinating their movements via free agency. Robert Downey, Jr.’s portrayal of Tony Stark, aka Iron Man, in 2008 set the stage for a new box-office (and now streaming) behemoth. And like it or not, Mark Zuckerberg’s invention of Facebook brought a paradigm shift to online privacy and socialization.
Federal Reserve Chair Jerome Powell may be next up. Investors have been bracing for inflation in the still-nascent Biden era. But how the Fed guides the economy forward will decide whether markets are in the midst of their own regime change or if investors can reuse their pre-pandemic playbooks. It’s looking for the moment like it could be the start of a new era in markets.
The central bank rolled out a new policy framework in August that targets inflation temporarily above 2% and maximum employment. Powell’s comments since then signal the Fed’s extremely easy monetary policy will stay in place well after the economy reopens.
The guidance, while vague, marks a stark shift from the recovery following the global financial crisis. The initial bounce out of the Great Recession quickly gave way to secular stagnation, a phase coined by famous economist Larry Summers to describe a period of weak growth and low inflation.
The Fed’s new strategy aims to learn from the last recovery and run the economy hot, bucking the decades-long precedent that explicitly links price growth with hiring.
“There was a time when there was a tight connection between unemployment and inflation. That time is long gone,” Powell said in a Wednesday press conference. “We had low unemployment in 2018 and 2019 and the beginning of ’20 without having troubling inflation at all.”
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NEW YORK – The Biden administration’s US$1.9 stimulus package, adding to last year’s $2 trillion in Covid-19 related handouts, has the effect of feeding sugar to a diabetic. The patient is on a sugar high, but at risk of collapse. The US doesn’t have the productive capacity to meet the demand created by the federal government and the Federal Reserve. The result is stagflation—a combination of inflation and economic weakness that we last saw during the Jimmy Carter administration in the 1970s. There are two big differences between now and the 1970s, though. The first is the explosion of US government debt. The second is China. Instead of throwing money out of helicopters, the US should invest trillions of dollars in infrastructure, R&D,