- Jay Powell announced the Fed’s adoption of average inflation targeting in his Jackson Hole address yesterday; the remarks contradict his concerns from 2012 that explicit targeting policies would force the Fed to keep an ever-growing balance sheet to support the economy
- If the 1940s, when rates were kept low even through rising wartime inflation, hold any precedent, another decade of QE and interest rates at the zero-bound now seems guaranteed; however, the ability to do future QE depends on Congress keeping up its stimulus spending
- Because zombies will strangle growth, absent a bursting of risky asset bubble, stagflation is a likely outcome as rates ultimately rise on the back of unlimited QE; given unemployment troughs long after recessions end, there’s no telling where the Fed’s inflation engineering attempts will lead
Here at Quill Intelligence, we pride ourselves on our etymological efficacy. Upon listening to Federal Reserve Chair Jerome “Jay” Powell’s virtual Jackson Hole confab speech, we approached our takeaway with as much introspection as we do any source of inspiration. With delight, we share with you that the word “bull,” which, in the name of propriety, we’ll leave in its shortened form, has a rich, albeit unverifiable, origin. One theory speculates the compound word began as a disdainful reference to papal edicts known as bulls (from the bulla, or seal). Given our affection for colorful historical figures, we delighted in another conjecture ascribing its derivation to the famously inane Obadiah Bull, an Irish lawyer in London during the reign of Henry VII. Helpfully, for the sake of our collective gentility, and despite its lost origins, time has produced a plethora of alternative interpretations ranging from the serious – deceit, trickery, fraud – to the light-hearted – drivel, hogwash and malarkey.
The bottom line: Powell spewed a bunch of, ahem, poppycock in his prepared remarks and during the Q&A. The Fed is in a bind of its own making, one Powell himself eloquently warned of at the December 2012 FOMC when the decision was taken to assign targets for the unemployment rate and inflation:
“I’m concerned that the actions contemplated in this meeting are setting us on a path to a much larger balance sheet with likely benefits that are not commensurate to the risks that we’re bearing. It will be very difficult to get off that path unless we begin to prepare the markets starting with this meeting. If our actions at this meeting validate the markets’ expectations of $1.2 trillion in purchases, the costs of correcting that impression will go up, and our willingness to bear those costs may not. I’m not supportive of a program of that size, and I am concerned that we may be sitting on bad news in the form of disconnection between the expectations of 12 of the 19 participants and those of the market. It may be that publication of our balance sheet expectations would close that gap, and I’d like to see us explore moving in that direction for the March SEP.”
The most frustrating aspect is that Powell wasted the crisis, the opportunity to undo some of the damage that had been done, allowing the zombie corporations to be purged such that the future recovery was that much more open to new, productive, job-creating entrants. Instead, he doubled down and fathered a new generation of zombies. $2.5 trillion and counting later, even more leverage has been piled onto Corporate America’s balance sheet ensuring an even larger eventual graduating class of bankrupt companies forced straight into liquidation because they’ve burned through what’s left of their assets’ value. Such is the magnitude of the even bigger bubble created, Powell knows a repeat of seven years at the zero bound might not buy enough time.
A quick perusal of history landed Powell in September 1937 when the New York Fed set the discount rate at 1% and kept it there until January 1948 even through the rising inflation associated with firing up the war machine. That’s your “average inflation” making up for not being able to hit 2% since 2010.
Even better, the Fed was gifted the employment mandate in 1977. As you see in today’s chart, it takes even longer for unemployment rates to trough than it does for recessions to end. That’s where allowing as much time as is needed ensuring full recuperation of employment “shortfalls” comes into play. With luck, Powell has bought the Fed a decade at the zero bound and a decade of Quantitative Easing (QE), a prospect investors relish.
But here’s the catch. Wanting to do QE for a decade and having the paper to buy in the open market is only feasible if Congress keeps up its stimulus spending. Otherwise, the Fed will run out of paper to buy. (Google: Taper Tantrum). In no way is this a political statement, but Powell sure could use a Democratic sweep to maximize stimulus spending as far as the eye can see.
Even if the stars align, two things can go wrong. Starting with the easiest observation – bubbles do eventually burst. The more obscure is that the magnitude of money printing being contemplated could finally induce inflation of the market’s making. The market’s ancients, the bond vigilantes, could rise from their long hibernation at a most inopportune time, destroying the Fed’s narrative that it “wants to raise inflation expectations.”
Under the direction of Janet Yellen (not a typo), the Fed clearly believes inflation is not a credible threat. Wishing it away doesn’t make it so. Inflation is not gone for good even if it sure as hell better be given the chaos that would ensue in the credit markets. And by the way, stagflation would be the more likely outcome if the market was to push up rates. Refer back to those zombies strangling long-term growth prospects Powell is so gifted at nurturing. Few in the media dared to call BS on Powell. We just did.