A Well Respected Man
September 3, 2021
7 minute read
“He’s a well-respected man about town,
Doing the best things so conservatively.”
A Well-Respected Man
The Kinks 1965
There is no doubt that Jerome (“Jay”) Powell is a well-respected man – “doing the best things so conservatively.” He is the Goldilocks of Fed Chairmen, a solid Republican nominated by Obama to the Board of Governors, and Trump as chair of Federal Reserve in 2018. He has befriended the stock market by the tone of his policy stance – neither too dovish nor too hawkish. He is a Princeton grad and an alum of The Carlyle Group.
The Kinks write: ‘his world is built ’round punctuality, it never fails.” At the Jackson Hole virtual symposium, Mr. Powell suggested that the US economy would be strong enough for the Fed to reduce its $120bn monthly asset purchase program this year. He also manifested compassion for the front-line workers and confirmed that “joblessness continues to fall disproportionately on lower-wage workers in the service sector and African Americans and Hispanics.” A well-respected man, indeed.
Still, is “his world still built ‘round punctuality?” He can now continue to be late given the miss on the August job reports today with payrolls up 235,000 versus the “expected” increase of around 720,000. This miss was accompanied by a post-COVID low unemployment number of 5.2% with almost no jobs created in retail, hospitality and leisure, while professional and business services had solid gains. This was essentially caused by the Delta surge, and it shouldn’t be a surprise. The real surprise is that few economists took this into consideration when putting out their forecasts. The pent-up demand being created is significant, and as vaccinations continue to become more prevalent, and consumers become even more restless that there will be another future surprise – on the upside.
As is well known, US consumer prices have soared due to pandemic-induced demand and supply-chain bottlenecks, leading to an acute shortage of some goods, causing problems for many countries that are key to global supply chains. In addition, a new COVID-19 variant has been detected in South Africa with a unique ability to mutate. Vietnam, for example, with about 3% of the population vaccinated, and Malaysia and Indonesia, also with low vaccination rates, have seen factory activity significantly decline. That has left many well-known Western brands that rely on these inexpensive manufacturing centers to see a rise in costs. That means a long list of supply chain issues (“temporary,” of course...) from delays at ports to rising raw-material prices, and ultimately, to higher costs for consumers. That is the mainstream view.
Others believe these higher costs will persist for the foreseeable future.
The Jackson Hole virtual gathering of luminaries were also presented with a study[1] by three academics (Atif Mian, Ludwig Straub, and Amir Sufi) postulating that rising inequality is the more important cause of the long-term decline in interest rates: “What explains the decline in r? Rising income equality versus demographic shifts.” The minor trends accompanying rising inequality and contributing to this long-term decline in rates (1980 through 2020) were the “aging of the population, shifting patterns in global savings, and changes in how businesses invest.” They continue by positing that: “Policymakers should recognize that rising income inequality is more than a distributional issue; it is likely a central force shaping broader macroeconomic trends.” More succinctly, pre-1980 income inequality was much lower, and thus interest rates were more normalized. The critical question not fully discussed is whether this forty-year trend will end with the never seen before government intervention: the stimulus checks, the American Rescue Plan ($1.9tn,) the Paycheck Protection Program ($0.5tn), CARES Act ($2.3tn), mortgage forbearance, Main Street Lending Program, Primary Dealer Credit Facility, Money Market Mutual Fund Liquidity Facility, Municipal Liquidity Facility, Commercial Paper Funding Facility, the multi-trillion Fed bond-buying program, the eviction moratorium, the student loan payment moratorium, and the $5tn expected soft and hard infrastructure spending bill. This will result in over a $7 trillion deficit in 2021 with a deficit-to-GDP of 30%.
Will this full-tilt government intervention begin to turn around a 40-year decline in income inequality? Social justice and the increased and rapidly growing social safety net must be paid for. If we logically extrapolate the Mian, Straub, and Sufi study, this could result in a steady and long-term increase in higher interest rates.
Inflationary pressures have jumped higher and faster than most economists (including those at the Fed) expected, and PPI, on an unadjusted basis, rose more than expected to the uncomfortable level of 7.8%for the 12 months ending in July – the largest advance since 12-month data were first calculated in November 2010. Let’s not forget that PPI serves as the leading indicator for CPI. Still, the Fed has long said that this inflationary pressure will fade over time. How much time? Six months? Two years? Five?
Nevertheless, enough policymakers have become more attuned to the risk that inflation could persist. In addition, there is massive pressure for the Fed to exit from its historic easing policy. This will most likely feed into inflation expectations and become self-fulfilling. Inflation is, in part, psychological, and the more we talk about it, the more we expect it, the more likely it is to occur.
Our tolerating these higher inflation levels is also demonstrated in panic home buying (which may well turn into a buyer’s remorse market) and car dealerships refusing to negotiate as they have done for so many decades. There is little rationale for a home to be sold in late 2019 for $625,000 and trade at $1.1mm today. Whether for permanent home ownership or investment property buying, prices rarely careen out of control forever and usually revert to a mean. That mean will still be considered inflationary. It is incredible to see that the S&P CoreLogic Case-Shiller National Home Price Index rose 18.6% in the year that ended in June, up from a 16.8% annual rate the prior month. June marked the highest annual rate of price growth since the index began in 1987. Finally, sales of securities backed by risky corporate loans hit a new monthly record last month as investors continue to grasp for yield.
The Fed is still set to begin tapering, all the while attempting to stop any future taper tantrums. Given the head fake from the August payroll numbers, it will be later than expected, but too late to ease inflation concerns. It matters how they ease their purchasing of $80bn of Treasuries and $40bn of mortgage-backed securities a month. What we do know is that the Fed’s $8T balance sheet will have to go on a diet, and higher inflation and low-interest rates cannot coexist forever. Any well-respected man knows that!
George Lucaci
Global Head of Distribution
FolioBeyond
www.foliobeyond.com
glucaci@foliobeyond.com
908-723-3372
[1] https://www.kansascityfed.org/documents/8337/JH_paper_Sufi_3.pdf
