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- 🔔 Zoltan Says The Quiet Part Out Loud
🔔 Zoltan Says The Quiet Part Out Loud
You might not know who Zoltan is. Let's give him a proper introduction before we explain his devious plan to get the Fed out of a hole... 👇
CS
TL;DR He's been around the block and knows a thing or two. These days he usually specialises in confusing everyone with extremely technical explanations about financial plumbing, especially in repo markets.
Which means the usual reaction to Zoltan's reports goes something like this 👇
But Not Today!
Zoltan went full off-piste and called for a Volcker moment... 👇
My friend Paul (Volcker) became chair of the Federal Reserve System in August 1979 after being nominated by President Jimmy Carter, at a moment when America was beset by national doubt and stagflation.
He immediately set to work to tame inflation, which was running out of control, and rapidly increased interest rates.
They peaked at 20% in December 1980.
(The fed funds/base interest rate was 11.2% when Volcker took over in August 1979)
Paul succeeded in halting inflation, and in doing so he re-established central bank credibility, even if the monetary policy medicine caused a sharp slowdown in 1981 and a recession in 1982.
Via William Rhodes
So THIS is what Zoltan's calling for...
The worst thing? It's incredibly logical.
Hold your fire, I'm not saying a recession would be a good thing.
Let me explain as simply as I can...
Inflation in the US is high (you may have heard 🙄), and the Fed is woefully ill-equipped to deal with this.
Why? Because monetary policy has long and variable lags. It takes time to filter through the system.
Think of it this way...
When the Fed finally hikes rates by 0.25% (or even 0.5%) on March 16th, who's actually going to cut back on their spending the following day, week, or even month?!
Nobody!!!
But over time their mortgage rates creep up, refinancing and personal loans become more expensive, company margins are squeezed, pay rises are less frequent (etc.) and spending eventually slows.
If you estimate the true lag in monetary policy at 12 months before it has a tangible effect on the economy (which is probably on the low side), it's pretty useless right now.
Especially if you consider that inflation is more of a psychological/behavioural phenomenon than a monetary one (Milton Friedman rolling in his grave at that but idc).
Vincent Deluard ran some inflation numbers using World Bank data 👇
Across 352 spikes of inflation >7% in the world bank data, price stability was fully restored just 1.4% of the time
The Fed and the ECB expect inflation to fall to 2% in 2022-25. How likely is that?
I recorded 352 spikes of inflation >7% in the world bank data
Price stability was fully restored just 1.4% of the times
The market is not pricing the most probable outcome: Position accordingly. pic.twitter.com/HHCaen1zTz— Vincent Deluard (@VincentDeluard) February 16, 2022
There's an obvious caveat: The data used goes back as far as 1871, and the economy has changed multiple times over that period.
Still, Vincent finds that high inflation usually begets high inflation and it's hard to stop once the inflation genie is out of the bottle.
And the longer it hangs around, the more we all become accustomed to it and adjust our behaviour accordingly...
It starts at the top.
In recent earnings calls, companies are grandstanding about their pricing power and how they've been upping prices. Only a few have expressed concerns about keeping it going...
So, does this mean inflation's now entrenched?
Some think so...
GOLDMAN SACHS CEO SAYS "WE ARE MOVING INTO A PERIOD OF ABOVE TREND INFLATION"- CONFERENCE— *Walter Bloomberg (@DeItaone) February 17, 2022
*SOLOMON: INFLATION HAS RISK OF BEING `REAL HEADWIND' TO GROWTH— *Walter Bloomberg (@DeItaone) February 17, 2022
GOLDMAN SACHS CEO - "WE MIGHT HAVE A PERIOD OF TIME WHERE THERE'S LESS ASSET APPRECIATION"— *Walter Bloomberg (@DeItaone) February 17, 2022
He sounds sure, but who knows? Wage growth doesn't seem to be quite keeping pace and maybe it is just a temporary high from mammoth fiscl and monetary support...
That said, there's no doubt that the longer inflation hangs around at high levels, and/or the more it expands from goods into services (broadens), the higher the odds are that the Fed goes full Volcker...
And the obvious thing to target is asset prices.
In Zoltan's words:
The two big components of services inflation are OER (Owner's Equivalent Rent) and all other services. The former is a function of house prices, the latter is a function of labor supply.
Both respond to financial conditions, and financial conditions are driven by long-term interest rates (term premia) and less so by short-term interest rates.
The large number of hikes the market has priced and the Fed implicitly sanctioned has had little impact on long-term interest rates, mortgage rates, or equities to date.
Don’t get us wrong – there’s been some impact, but not enough.
More is needed.
To slow OER inflation, mortgage rates need to get higher and house prices flat or outright lower. To slow all other services – driven by a shortage of labor –we need more supply of labor, not less demand for it through a recession.
Again, inclusive low unemployment is a political imperative and, by extension, so is redistribution via stronger wage growth.
If we agree on that, what follows is that we need to slow services inflation by slowing, not killing, wage growth, by bringing about more supply of labor, not less demand for it via a recession.
Maybe to increase labor supply, we need lower asset prices…
Which would mean you can forget your Fed Put at 10/20%.
JayPow hasn't forgotten (or forgiven) those money printer gifs you made...
And if you want to do the whole FIRE thing (Financial Independence, Retire Early).... You can't. Your country still needs you...
Consider that even after pulling back from 4800, the S&P 500 still sits ~30% above the pre-Covid highs.
Zoltan concludes:
The decisions of central bankers are always redistributive.
For decades, redistribution went from labor to capital.
Maybe it’s time to go the other way next. What to curb?
Wage growth? Or stock prices? What would Paul Volcker do?
Some will say that he should retreat back into his world of financial plumbing and stick to what he's good at.
I'm not one of them. It's an interesting perspective from someone who's worked extensively with policymakers around the globe. Someone who understands how they think...
It doesn't matter if you think it's the right response. If you believe the Fed are trapped, then they'll need to find an outlet...
As Sun Tzu says in the Art Of War:
When you surround an army, leave an outlet free.
("to make him believe that there is a road to safety, and thus prevent his fighting with the courage of despair.")
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