Inflation? Market Has No Fears (For Now)
SriKonomics has long maintained that continued monetary stimulus from the Federal Reserve is largely attributable to two factors — the central bank having boxed itself into that position to support equity investors, and absence of other arrows in its quiver. Both were manifested, perhaps unwittingly, in statements by leaders of the Fed and Treasury on Thursday.
In his semiannual presentation before the Senate Budget Committee, Jerome Powell admitted that “the shock going through the system . . . has driven inflation well above 2%. And of course we’re not comfortable with that.” He had repeatedly justified a near-doubling of the Fed’s balance sheet since March 2020 by insisting that the pickup in inflation is “transitory” due to supply bottlenecks. He switched position last week, saying that he was not sure the acceleration in inflation wouldn’t spread to sectors not affected by bottlenecks.
In following up on his new concerns, Powell was not going to taper bond purchases or even provide a timetable for doing so. Of that he was sure. Why spook equity markets that were hanging on the Chairman’s every word to reach new record highs?
Speaking on CNBC TV on Thursday, Treasury Secretary Janet Yellen said that even the “several more months of rapid inflation” that she anticipated did not worry her as much as the impact of surging home prices on low-income earners seeking to buy their first home. The Case Shiller index released a couple of weeks earlier showed that home prices had surged by 14.6% over the past year, the highest reading in over 30 years.
What is startling about Yellen’s comment is that the Federal Reserve has been purchasing mortgage bonds at the rate of $40 billion per month over the past 16 months, indirectly pushing home prices up faster than they would have risen otherwise. Was the Secretary not aware that the central bank was contributing to higher home prices even as she worried about it?
And how is the Fed worsening economic disparities between the rich and poor by boosting home prices? Through the continuation of near-zero policy interest rate set at the start of the pandemic and purchases of mortgage bonds backing the surge in asset prices, putting them beyond the reach of sheer wage earners.
None of the statements by the policy chieftains frightened the bond market. Not even the news release on Tuesday by the US Bureau of Labor Statistics that consumer prices had risen by 5.4% over the past year, the fastest since August 2008, meant much. On Wednesday, we learned that producer prices for final demand increased by 7.3% over the past year, the fastest since November 2010. This pushed the yield on 10-year Treasurys by some 5 basis points to 1.42% but Powell’s speech to the House Committee on Financial Services that afternoon promising to continue quantitative easing calmed market fears. The 10-year ended the week at just 1.30%.
All these conflicting forces leave investors to make a crucial decision that will affect their portfolios and retirement plans: abandon economic theory, ignore market data and put trust in Uncle Jay and Aunt Janet? Or swim against the tide and expect bond yields to surge? As a long-term follower of US monetary history, I would bet with the latter prospect.
Yes, Powell and Yellen have won the battle with the markets. But the longer they succeed in individual skirmishes, the more likely that they will lose the war. Experience from the 1970s suggests that it becomes increasingly difficult to tame inflation the longer it is allowed to fester. Subduing inflation after a prolonged experience with it also makes it that much more painful in terms of the impact on the economy and employment.
Dr. Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
July 17, 2021
Sri-Kumar Global Strategies, Inc. advises multinational investors and sovereign wealth funds on global risk and opportunities. Dr. Sri-Kumar is regularly featured on business TV and Radio media, and is a frequent speaker in global financial centers on major topics that affect markets and investments.
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