Old "Rules" Don't Apply!

Well, I'm already breaking my own new rule, by publishing two blog posts on the same day... Can't resist it this morning... I.e., I don't want this one to get lost in the shuffle of next week's summary.

This morning's log entry:

4/27/2024

This from Grant Williams' podcast guest is, in essence, what I’ve been describing during client review meetings of late…

I.e., In terms of what he says about how policy will be implemented going forward, I couldn’t agree more!

Emphasis mine:

Gerard Minack (00:13:21):

“That is a risk, but I think, look, one of the big reasons I’m no longer a card-carrying secular stagnationist, is that I think in the pandemic policymakers did rediscover the joys of fiscal, and there was a tacit link with central banks doing QE. I think after the post-GFC experience, no one could really see QE as an effective stimulant. If it was an effective stimulant, I didn’t see it in Europe or the US or the UK post-GFC, none of it worked. What was uncanny, however, was how we saw a matching increase in the US budget deficit that was almost exactly matched by the size of the Fed’s QE program. So, there was, in a sense, independence, but the two arms worked cooperatively.

Now, is that a damaging lack of central bank independence? No, I would argue it’s a recognition that what actually works is fiscal, and that was the big mistake post-GFC. We dialed down fiscal stimulus way too soon. There was this fashionable idea of expansionary austerity, which proved to be as oxymoronic as it sounded. And what policymakers learned in the pandemic is, guess what? Sending checks to people is very effective as a stimulant and it’s very popular as a policy. And that’s a pretty irresistible combination. It works and it’s popular. They’re not going to forget that.

So I think in the future, one of the reasons that we’re going to see structurally higher rates, is every time we have a recession in future you are going to get cash drops, and that’s going to make for much more V-shaped cycles. And contrast that to, really, the three decades before the pandemic. Because central banks, their principal legal, which is interest rates, they were always asymmetrically effective. They could always hike rates to a level that would slow growth. They found it increasingly difficult to cut rates to a level that would stimulate.

So because we were just relying on them to push on a string, we had these increasingly saucer-shaped expansions, tepid recoveries. So here’s a statistic for you. Since the mid ‘80s, the average gap between the start of US expansion and the first Fed hike in that expansion has been 42 months, so three and a half years. It’s going to be three and a half years into an expansion before the Feds needed to hike. And that’s because the expansions all started so slow prior to 1980 when you had fiscal often playing a role, policy used to turn on a dime and the average gap was nine months. So if we had more aggressive fiscal stimulus applied at the bottom of a cycle, you’ll have rates having to head higher sooner.”

Here, in a nutshell, is how I’ve been explaining it to clients:

A new paradigm was set during covid… Essentially, past rules do not apply, there are zero limits to the extent to which policymakers will spend freshly printed money to boost the economy, and, therefore, to make voters happy… Folks will get unemployment boosts and stimulus checks fast and furiously when the next recession hits…Which makes for a potentially shallower drawdown in equities (during the next recession) than present valuations would suggest, and, virtually for certain, rapidly returning inflation at a rate notably higher than we’ve seen on average over the past, say, 40 years. 

The implications around that “rapidly returning inflation” make for a macro rich investment environment during the next cycle, if you know how to manage it!