By: Russ Kamp, Managing Director, Ryan ALM, Inc.
Early this week I published a post titled “I Don’t Get It”, in which I questioned the incredible reaction of market participants to last week’s modest improvement in the inflationary environment. Please understand that I’m not rooting for high inflation, rising rates, and falling returns for both equities and bonds, but I am questioning the reaction of market participants to the current events. Every article that I have read and continue to read that cites comments from US Federal Reserve Governors supports the notion that there is NO PIVOT in our immediate or near-term future. The language being used seems to be fairly straightforward English. There is no “Fed speak”. Yet, there seems to be a great expectation among market participants (perhaps hope) that the Fed will soon declare victory! They will soon announce that everything that they had set out to tackle has been accomplished. Inflation has been tamed and the Fed’s 2% target has been met. Victory is ours!
Yet, as much as I would like to believe that I don’t think that the Fed is close to accomplishing what they set out to achieve. I don’t believe for one minute that they will soon divulge that they were only kidding that their mandate was to tame inflation down to a 2% level. You see, with the CPI sitting at 7.7% and the core inflation rate at 6.3%, they haven’t gotten to a level of “real” rates – not even close. Furthermore, with US Treasury Bonds, Notes, and Bills rallying during the last month, the Fed’s job has gotten harder in its attempt to tamp down inflation. How much economic activity will truly be thwarted by a Fed Fund’s Rate with a range of 3.75 to 4.0%? Remember, in 1980, when we last experienced the ravages of high inflation, US interest rates reached double digits and the Fed Fund’s Rate hit 20%! Furthermore, US unemployment was nearly 10% and not the 3.7% level that we currently sit at.
So, if you don’t believe me, here is a bit of sobering commentary from St. Louis Fed President James Bullard who said, “interest rates have not reached a level that could be justified as sufficiently restrictive, even with generous assumptions.” Furthermore, “to attain a sufficiently restrictive level, the policy rate (Fed Fund’s Rate) will need to be increased further”. He went on to say that the FFR would need to reach a minimum of 5% and possibly as high as 7%. There shouldn’t be any misunderstanding with what he’s said, and his fellow governors have been sharing similar expectations/thoughts.
I suspect that nearly 40 years of Fed easing could possibly blind some people to the fact that US Fed policy isn’t always accommodative. The road to ZIRP contributed significantly to our current inflationary environment. It is highly unlikely that this Fed makes a U-turn back onto that path. They seem singularly focused on not repeating the mistakes of the Federal Reserve during the 1970s. If that is true, brace for higher rates, choppy markets, and an inflation struggle that takes longer to rein in.
You’re not missing anything. We have further to go in this bear market.
Unfortunately, I believe that you are right. The market is discounting too many potential risks. Happy Thanksgiving! Russ
Happy Thanksgiving to you also!