Detached from reality

Abraham George Market Musings

I don’t think I will stop writing about inflation until the cows come home. The Federal Reserve’s preferred measure of inflation registered another jump, hitting its highest level in three decades. Federal data on last Friday showed the core personal consumption expenditures (PCE) price index, excluding volatile food and energy, increased .4 pct in June for an annual gain of 3.5 pct the largest gain since Dec 1991.

Already, over the last 12 months, inflation has cut into wages. According to the National Review, the average loss is 1.9% . Of course, that’s the whole idea. Inflation is a tax. It takes money from wage earners and savers and moves it along to all sorts of crazy ideas. The Fed has its pet projects and transfer schemes.

Actually, if you have the pulse of the economy it is not difficult to understand inflation. It may not be as visual and obvious as you will observe in Argentina or Venezuela as opposed to the developed and developing countries but for the curious it is not a mystery.

The ordinary people who struggle to make both ends meet may not catch it immediately as they are always open to hand outs. The government or ruling party will pass out the money to “the people”. Out of gratitude, “the people” are supposed to vote the ruling party again to power for another four year term. Money is relative. In this transfer of money to the people, the rich always get more richer and the poor gets more poorer. In between, stands inflation.

Think of all the mischief the Fed and the government has been up to. On top of everything that the Trump administration did as a response to counter COVID-19 , the Senate quickly came to terms with passing an ‘infrastructure bill’ for $1.9 trio. On top of that, a Senate panel added another $25 bio to Biden’s already inflated defense budget. And then the Democrats said they were getting close to another $4.5 trio in spending, focused on ‘human infrastructure’.

Through all this the Fed is maintaining the stance and trying to convince the world that increasing the money supply by more than 30% over the past year is not inflationary.

Powell & Co claims that the rising prices that we are seeing everyday are purely the result of ‘base effects’ and ‘bottlenecks’. Their argument is that price data only looks high because it’s measured against a very low base of last year, when the economy was virtually shut down (base effects) and they have blamed higher prices on supply chain ‘bottlenecks’ which will ultimately normalize. Mind you, the term transitory started to be used widely after about a $3 trio of fiscal stimulus was already approved and was working through the economy, to such a degree that we were, already seeing a V shaped recovery (by late January) and projected by the Congressional Budget Office (CBO) to grow at 3.7% annualized rate (stronger than the pre-pandemic growth) with the unemployment rate falling to 5.3%. The lowest figure in last 50 years.

While Powell at the last FOMC press conference stumbled to explain ‘transitory’, he admitted there is massive inflation in the pipeline. But his argument is that the peak rate of change will not be persistent.

Are the people really buying his story? We don’t have to look any further than the bond markets. Real rates as measured by the difference between yields on treasury inflation protected securities (TIPS) and regular treasuries have been surging higher. It means TIPS are dramatically outperforming treasuries right now. Since TIPS trade based on inflation expectations, this suggests the bond market is predicting much higher inflation. With another round of money printing, the markets are not willing to buy the Fed’s narrative.

Though the Fed has been hinting that it intends to taper their program of monthly $120 bio per month of QE and probably raise rates by late 2022 or early 2023, one has to take into consideration the politics behind it as well.

The Biden administration has already leaked that they intend to give Powell a second term as Fed Chairman starting in 2022. I think Powell may have cut a deal with Biden to stay on as Fed Chair. Why would Biden continue to favor Powell? “Be on board with my agenda”. Keep the economy as strong as possible going into the 2022 mid-term elections.

Meaning no tapering, no rate hikes and no tightening of monetary conditions for the foreseeable future. Sure, the Fed will jawbone and do a lot of political posturing but don’t think there is any chance of tightening monetary conditions in the near future.

End result: Inflation will continue to rise and finally the Fed will kill it. We are not there as yet. It will be a hard landing.

Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.