Fed boss Jay Powell is like a dangerous driver.
Reckless… and hell-bent on accelerating, whatever the cost.
Problem is, right now, he’s barely moving! And that’s frustrating for old Jay.
Which is why he’s been frantically fiddling under the bonnet.
Tinkering with the engine
Doing all that he can to get the engine fired up and the car running well.
And although he’s been at it for years…
… trying to move the needle on the speedo to optimum…
He’s failed miserably.
That’s even despite all the fuel he’s put in the tank…
And all the tinkering and greasing of the moving parts.
It’s just not responding.
So, he’s going to have to do more – maybe a lot more.
Trouble is, sooner or later there’s going to be a tipping point…
When suddenly, it’s all going to kick in… the revs are going to go through the roof… and if he’s not very careful, the car is going to be out of control.
Inflation won’t budge
I’m talking about how Powell’s trying to juice the US economy.
But more specifically, about how he’s obsessed with sparking inflation.
By doing a U-turn last year and cutting interest rates three times… and by injecting liquidity into the markets by expanding the Fed’s balance sheet.
As a Monkey Darts reader, you’ll know that’s keeping the US stock market roaring higher.
The Dow’s up 8.5% since the they started cutting rates in July.
By that measure, asset price inflation is rampant.
And whilst that might be Donald Trump wants – because it keeps the rich voters onside – it’s not what’s on Jerome Powell’s mind.
What Powell wants is a steady rise in real inflation – a rise in the prices of goods and services. The economy depends on it.
It’s a bit of a conundrum this inflation business. I wouldn’t want to have Powell’s job of trying to figure things out so it’s just right…
Too-low inflation – or worse, deflation or falling prices – is bad for the economy.
When prices start falling, consumers stop buying… hoping for even better deals down the line. Bad for businesses and bad for the economy,
Too-high inflation can be just as dangerous, though.
I’m talking about when prices start rising out of control – something nobody seems to be thinking about as a threat right now.
Economist Edmund Conway explains:
“Prices can sometimes rise exponentially in what is commonly called an inflationary spiral. The higher inflation goes, the more discontent it causes among workers, who see their standard of living deteriorating. They demand higher wages, and if they succeed, they spend their extra cash, which in turn prompts shopkeepers to raise prices. This pushes inflation still higher, which sends employees back to their bosses for more pay rises.”
It can soon turn ugly – and totally undermine the economy… and the stock market, as the crowd liquidizes their portfolios.
As Conway puts it, “when businesses and families feel insecure about how fast prices are rising or falling, they put off investing and saving, and normal life grinds to a halt.”
So, spiralling higher inflation is a no-no.
But a gentle, stable rate of price inflation, one that’s anticipated by businesses, workers and consumers, is good.
At the right level, it encourages consumers to spend and keeps businesses profitable.
That’s why central banks – and Jay Powell at the Fed is in focus right now on this – want gentle, predictable inflation.
The problem is that so far, at least, inflation in the US won’t budge.
Which is why he’s throwing everything at it – low interest rates, huge liquidity splurges – to try to get inflation up.
And that could be a problem down the line…
If he’s not careful, it’s going to explode higher at such a rate he’ll be unable to contain it.
Inflation can do that. It can get out of control.
And if he loses control of inflation, Trump’s “miracle economy” is doomed.
As is the great stock bull market of 2009-202?.
Not that many people are paying attention to that threat.
Not right now, at least.
My bet is that could change. People might start figuring it out.
Because I can see the Fed and Jerome Powell being in the news a lot more regularly in the months ahead.
Especially with the US election coming up in November.
Trump needs Powell onside… keeping the party in the markets going.
I wouldn’t even rule out some more tinkering from the Fed… more asset purchases to keep the financial system moving.
And possibly even further rate cuts… to tease inflation higher.
“Fed Adds $82 Billion to Financial Markets”, ran a Wall Street Journal headline on Tuesday.
The article goes on:
“Big banks’ demand for longer-term Federal Reserve liquidity flared up again on Tuesday, on a day where the central bank extended its plans to intervene in markets into mid-February… Collectively, the Fed added $82 billion in temporary liquidity to the financial system.
And, reports the WSJ, that was on top of the $60 billion of liquidity the Fed pumped in the day before.
According to macro analyst, Dan Denning, quoted in BullionVault:
“The taps are open and gushing. The Fed’s pumped $300 billion in liquidity into markets since mid-September. The Fed’s balance sheet is back over $4 trillion. At this rate, the balance sheet will go over $4.5 trillion by May of next year – a new record.”
See… the Fed is throwing everything at it. And to achieve its goals, it may have to throw even more.
The Fed’s main job is known as its ‘dual mandate’. Although basically it comprises three goals:
- Maximum sustainable employment;
- Stable prices (inflation);
- Moderate long-term interest rates;
On employment, that’s not to say the goal is for every worker to have a job.
It doesn’t set out to achieve 100% employment… or 0% unemployment.
Neither of those are possible, given that people are always quitting jobs and starting others. Or there may be some companies or sectors contracting… whilst others are expanding.
There will always be some workers not in employment when the numbers are counted.
“Maximum employment… is the level of employment that is likely in normal economic conditions when there’s neither a boom nor a recession.”
Latest numbers put the unemployment rate at 3.5%. That’s where the Fed wants it.
As for inflation, the most recent data says it’s at 1.7% compared to the Fed’s target rate of 2%.
The Fed adopted that target rate in 2012. But it’s never managed to hit that level for any length of time since.
Which is why Powell’s under the bonnet, spanner in hand, trying to make it tick… faster.
He’s in a bit of a Catch 22.
Trump wants Powell to cut interest rates further.
And Powell would probably like that too – to encourage borrowing and consumption… and push inflation higher.
What happens if interest rates go too low (they are ALREADY historically low, remember)?
If they go too low, it weakens his disaster defences.
Bear in mind that during the financial crisis of 2007/08, the Fed was able to slash rates from 5.25% to 0.25%.
It was that action that ended the crisis (well, that and the back-up of billions of dollars of quantitative easing).
Rates are already low at 1.5%.
Already Powell has little defence in case of a serious economic downturn.
Which is why he’s holding off for now.
And the message to the markets is: everything’s under control. No need to cut rates. Inflation will come – gentle, stable inflation, that is.
If so, that’s fine. Markets should handle that. And the economy will strengthen.
But what if inflation comes roaring back – spiralling out of control?
Kevin Muir at The Macro Tourist believes it could:
“I believe we are on the cusp of a dramatic economic shift. In 1981 no one could imagine inflation doing anything except go higher. Today we are at the opposite extreme. Investors are convinced the three D’’s (debt, demographics and disinflation from technology) doom us to a world of extremely low inflation (and interest rates) … Inflation has been almost priced out of financial assets. No one believes it will return, so there is little reason to hedge for it. Inflation protection is dirt cheap.”
And if the situation that has driven this bull market for the past 11 years were to change… what does that mean for stocks?
I don’t think it’s unreasonable to suggest that the stock bull market could be in danger.
That’s not to say we should be selling all our stocks and sitting in cash, waiting for a crash so we can buy back in cheap.
It’s impossible to time stuff like that. And generally, the time-tested advice to stay invested in the market has been proven to be right.
But it’s worth considering taking some profits on overpriced stocks – or at least using stop losses to limit the downside.
And it’s worth keeping hold of and even increasing your position in disaster hedges like gold.
If Powell’s plan backfires and he kicks of a spiral of inflation which crushes the stock market, gold could be a great store of value.
As for cryptos, they’re untested in all this. They’ve given back a lot of the speculative gains they made in the euphoria of 2017.
But as Crypto Traders Academy members will know, the price of Bitcoin and Ethereum have come to life in the past few weeks.
They’ve leapt 39% and 47% respectively in the last month.
And head of Crypto Traders Academy, Michael Mac, pointed out recently, they both spiked higher over all the trouble in the Middle East earlier in the month.
That suggests they’re being viewed as a hedge against volatility in the wider financial markets.
And it’s entirely possible that if we see signs of inflation getting out of control, capital will flow into assets investors believe could outperform.
Could Bitcoin, Ethereum and other cryptos benefit from such a move? We’ll have to wait and see.
Meantime, to see Michael Mac’s latest analysis – and why he believes there’s a huge crypto boom coming – check out his Crypto Traders Academy.
You can start a 90-day risk-free trial here.
And if you like what you see, consider taking small positions in some of those coins Michael likes. It’s a way to spread your overall asset risk.
And if he’s right, then you could do very well in the years ahead, whatever happens with inflation.