Whatever It Takes Part II and the New “Fed Put”

On Wednesday, one portion of the Federal Reserve’s Federal Open Market Committee (FOMC) statement immediately caught my eye, a very significant change from the May FOMC statement. In May, the statement read:

“With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2% objective and the labor market to remain strong.”

In June, the statement read:

“The Committee seeks to achieve maximum employment and inflation at the rate of 2% over the longer run.”

The FOMC statement dropped the reassurance that the labor market could say strong as they go about the business of trying to rein in inflation. To me anyway, that omission was another clear, “Whatever it takes” message from the Fed. The financial markets mostly seemed to “oh-hum” it.

Then Chairman Powell began the press conference with this:

“Good afternoon. I will begin with one overarching message.

We at the Fed understand the hardship that high inflation is causing. We’re strongly committed to bringing inflation back down, and we’re moving expeditiously to do so. We have both the tools we need and the resolve that it will take to restore price stability on behalf of American families and businesses.”

Again, the markets really didn’t take that message to mean much and after a few polite responses to questions that didn’t seem quite so hawkish, stocks began to surge higher and interest rates plunged. I found this odd since this was the same exact pattern that we saw the day of the May FOMC. Moreover, about halfway into the press conference, Bloomberg’s Mike McKee asked Chairman Powell:

“Are you targeting headline inflation now or core inflation? In other words, how far would you chase oil prices if they keep going up, if that’s going to be the component that drives expectations? Would you risk recession for a headline rate if the core rate is holding steady or starting to go down?”

Chairman Powell responded,

“The current situation is particularly difficult because of what I mentioned about expectations. We can’t affect, really—I mean, the energy prices are set by global commodity prices, and most of food—not all of it, but most food prices are pretty heavily influenced by global commodity prices, too, also other things. So, we can’t really have much of an effect. But we have to be mindful of the potential effect on inflation expectations from the headline. So, it’s a very difficult situation to be in, and we—again, we can’t do much about the difference between the elements that make up the headline that are not in core.”

It seems to me that the Chairman was describing the very real threat of stagflation for us. The thought of stagflation naturally brings us back to the last time we suffered through this condition in the 1970s. Much like today, an overstimulated economy driven by super-accommodative monetary policy and massive federal government deficit spending met a supply shock in energy. This time around, the things the Bernanke-Yellen-Powell Federal Reserve has done make the Federal Reserve of the mid-1960s to early 1970s look like the Grim Reaper as opposed to Santa Claus. Additionally, the energy shock dynamic is worse in my opinion.

Unlike the 1973 energy crisis that led to a deep inflationary recession in 1974-1975, the energy crisis then was really a diplomatic one. In the 1970s, OPEC was making a statement, and eventually, it was heard loud and clear. At the end of the day, OPEC nations still needed to sell their product to those it launched the embargo against, the West. Therefore, peace, however uneasy was reached.

This time it is the other way around. The old embargo targets, the West, have put their own embargo on a major oil producer, Russia. Moreover, the issue with Russia is a whole lot stickier than the situation in 1973 ever was. This puts the Fed in the position of having to hammer down on aggregate demand (the only real thing they can do) and pray for the best on the energy and supply chain front. That spells recession with continued high inflation to me. Moreover, not necessarily the shallow recession that some Wall Street economists are predicting if they are predicting one at all.

I read a very interesting article in Money Week by Barry Norris, founder of Argonaut Capital, titled, “Investors beware–the 1970s Nightmare is Back.”

Norris writes, “Contrary to the common myth, inflation hits those with capital surpluses–the few or the retired–worse than the many in the general working population. “

He then goes on to lay out what happened to investors in both the U.S. and U.K. equity markets in the 1970s in both nominal and real returns.

“The problem for financial markets in the 1970s was high and persistent losses in the purchasing power of fiat currency. Inflation in the U.S. was just 1% in 1964 but averaged more than 7% a year during the Seventies and peaked at 15% in 1980...If you were unlucky enough to buy the U.S. at its peak in 1973 you would still have made 21% over the next decade in nominal terms. But in real terms a loss of 48% for U.S. investors.”

The battle between the few with capital surpluses (the rich) and the many without has raged for centuries. Remember in history class when you spent about 12 minutes on the turn of the 20^th century progressive political movement? You probably had to remember that presidential candidate, William Jennings Bryan made a famous speech “Cross of Gold” and that was about it.

However, the Cross of Gold was a rallying cry over monetary policy where those with significant financial assets were protected by a hard money monetary policy at the expense of the many who did not own financial assets. Bryan finished his speech with the famous quote, “You shall not crucify mankind upon a cross of gold.” Bryan ultimately lost. Inflation is terrible for the average person but at least they are employed and like we see today, getting nominal pay increases. However, if we just look at “returns," the few have a lot more to lose than the many.

Up until recently, we referred to “The Fed Put” as the Fed saving financial assets by providing massive amounts of liquidity to the markets to stabilize and turbocharge demand. However, we face a completely different problem in 2022. In this case, the Fed essentially must do the opposite in order to kill inflation. The new “Fed Put” may very well be engineering a much deeper than expected recession to rescue “the few." I will put my money on that.

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