From TheMarket.ch, March 15:
SPACs are hot, the IPO market is hot, credit markets are hot, commodities are hot, the crypto markets are hot. Everything is hot – only the Consumer Price Index is cold. And that is all that matters for the Fed.
The Boston Herald reported in May 1924 that a police officer, upon seeing a man groping around the pavement on his hands and knees, had asked for an explanation. «I lost a $2 bill down on Atlantic Avenue», obliged the man. «Then why are you hunting around here in Copley Square?» The man paused and turned his gaze upwards towards the officer, «because the light’s better up here».
The so-called «streetlight effect» is now a well-documented phenomenon. According to Wikipedia, it «is a type of observational bias that occurs when people only search for something where it is easiest to look».
We feel it an apt description of modern central bankers’ narrow fixation with the Consumer Price Index (CPI), driven not by any richness of information relating to the economy’s «overheating», but because it's easy.
Stimulus today is excessive and credit conditions loose in part because central banks are relaxed towards the risk of CPI inflation. On this they might be right. But they are similarly relaxed over obvious signs of overheating in financial markets, and on this we are sure they are wrong.
The historical precedents we explore below do not bode well. We think it likely that we’re in the foothills of a policy mistake of epic proportion which will have potentially devastating consequences.
Powell’s reading of economic history
Before explaining why though, let’s first remind ourselves of the Fed’s current thinking. Jerome Powell was recently asked by Harvard’s Greg Mankiw on CNBC’s Squawk Box about how the Fed were thinking about the risks of inflation. The answer was comprehensive and is worth reproducing almost verbatim:
«The big picture is still that we’ve seen … three decades, a quarter of a century, of lower and more stable inflation and we’ve seen really the last decade be characterized by global disinflationary forces and large advanced economy nations struggling to reach their 2% inflation goal from below. So that, I think, is the broader setting.
In addition, the pandemic itself has produced lower inflation readings … as we look forward we’ll probably see an increase in readings but that’s really not going to mean very much, it won’t be very large or persistent in all likelihood, it's just a function of those readings falling out … if the economy reopens, there’s quite a lot of savings on peoples’ balance sheets, there’s monetary policy, there’s fiscal policy, you could see strong spending growth and there could be some upward pressure on prices. Again, though, my expectation would be that that would be neither large nor sustained…
We have had inflation dynamics in our economy for three decades which consists of a very flat Phillips curve, meaning a weak relationship between high resource utilization, low unemployment and inflation, but also low persistence of inflation, critically … of course those dynamics will evolve, but it's hard to make the case why they will evolve very suddenly, in this current situation.
I described our new framework and our guidance, in major part we are looking at actual inflation, we want to see actual inflation, and part of the reason for that is that all during the long expansion, many of us - and that includes me - were writing down a return to 2% inflation, and maybe a mild overshoot, year after year after year. And year after year inflation fell short of that. So we have tied ourselves to realizing actual inflation for example, that’s the way our rate guidance works is, you’d have to see inflation reach 2% - not in a forecast, but actually. So we are looking at actual inflation.»
Powell and other members of the FOMC have said they don’t expect to tighten policy «any time soon». According to Chart 1, which plots the expected policy rates, markets believe him. He describes the new framework as «a patiently accommodative monetary policy that embraces the lessons of the past» namely, that policy has been tighter, and so employment lower than was necessary because economists were overestimating inflation risk. He seems determined that there will be no such error on his watch.
The Calderwood Capital reading of history....
....MUCH MORE
