Monday, November 14, 2022

Morning Note: Powell's Problem

My dialog yesterday evening with our well-tutored, deep-thinker on markets, on the economy and on history, friend/client Sam is timely and instructive enough to use as this morning's main message.

Sam offered up an accurate depiction of the rate environment of the late-70s/early-80s:

"The Federal Reserve board led by Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. The prime rate rose to 21.5% in 1981 as well, which helped lead to the 1980–1982 recession, in which the national unemployment rate rose to over 10%."

And went on to acknowledge that Powell has a vastly different debt backdrop (far more constrictive) than did Volcker back in the day. 

Although Sam acknowledged Powell's desire not to make the mistake of not raising rates enough to ultimately quell inflation... Thus, in his opinion, the Fed will stay the course until inflation has abated significantly... Which, despite recent softer (but, clearly, still net hawkish) talk, makes sense, and is consistent with the Fed's general messaging.

In response to Sam's commentary I agreed that Powell faces a vastly different debt setup than did Volcker, and added that there are notably different structural factors in play as well. I then offered up this excerpt from our September 14 blogpost:

"...we simply haven't experienced inflation remotely to this degree since the days of Greenspan's immediate predecessor, Paul Volcker. And that, frankly, demands a Volckerian re-think of priorities for today's Federal Reserve.

Problem (big problem!) being, the underlying general setup today isn't remotely what it was when Volcker allegedly, in singlehanded fashion, slayed the 70s inflation dragon.

You see, back then we had the likes of Ronald Regan and Margaret Thatcher pumping supply side, globally-friendly economic policy into the world... I.e., they unleashed disinflationary forces that combined with Volcker's willingness to attack rising prices in a manner that his predecessors -- who operated within a labor-friendly, protectionist, inflationary regime -- simply couldn't successfully pull off.

Plus (big plus!), the US was sporting a mere 30% debt to GDP back in those days. I.e., the Fed could hike away without blowing up the credit markets... Today we're facing a debt load to GDP of 123%!! So, no can do on double-digit policy rates.

Legend has it that even Volcker -- himself being prone to recency bias -- was doubtful that his aggressive approach would actually do the trick.

Well, folks, we've come full circle. Globalization has, at least politically-speaking, run its course -- while wealth and income inequality have reached historic proportions. Therefore, the kinds of labor/consumer-friendly, protectionist, inflation-stoking policies that predated Volker, Regan and Thatcher are resoundingly back in vogue.

So what does that (along with historic debt to GDP) mean for present-day monetary policy? Well, it means that getting inflation back to the Fed's 2% target ain't gonna be easy -- not without breaking something in the process.

We'll see if, as some have suggested, the Fed doesn't actually articulate a goal other than 2% inflation at some point going forward... That's certainly within the realm of possibilities in our view...

Some form of yield curve control (à la the 1940s) -- where the Fed caps longer-term rates while allowing the economy to run somewhat hot -- to over time inflate away that debt to GDP number (i.e., inflate the economy faster than the debt piles up) may ultimately be on the table as well."
On another note, Sam went on to ask the following:
"What would happen to the world market, to oil, to the Euro market, and to US equities if there were the negotiation of a peace deal between Russia and Ukraine in 2023?"
My reply:
"Safe to say that, initially, we'd see a sharp decline in the price of commodities, oil and wheat in particular, and a rally in both equities and debt... Beyond "initially" things would settle back, and again reflect the long-term structural realities of today..."

And I did mean global equities and debt. 

Asian equities struggled overnight, with 11 of the 16 markets we track closing lower.

Europe's green this morning, with 15 of the 19 bourses we follow trading up as I type.

US stocks are leaning lower to start the session: Dow up 18 points (0.05%), SP500 down 0.36%, SP500 Equal Weight up 0.18%, Nasdaq 100 down 0.93%, Nasdaq Comp down 1.03%, Russell 2000 down 0.64%.

The VIX sits at 23.57, up 4.66%.

Oil futures are down 1.43%, gold's down 0.26%, silver's down 0.03%, copper futures are down 1.67% and the ag complex (DBA) is down 0.30%.

The 10-year treasury is down (yield up) and the dollar is up 0.70%.

Among our 35 core positions (excluding options hedges, cash and short-term bond ETF), 17 -- led by AMD, healthcare stocks, energy stocks, AT&T and defense stocks -- are in the green so far this morning. The losers are being led lower by Albemarle, MP Materials, Dutch Bros, Amazon and Sweden equities.

"There are only facts, not greater or lesser facts. The fact, the what is, cannot be understood when approached with opinions or judgments; opinions, judgments, then become the fact and not the fact that you wish to understand."
--Jiddu Krishnamurti

Have a great day!