Holding the Inflation Tiger by the Tail!

The Destruction of Wealth

I am old enough to remember peak US Inflation being a problem in 1980. US Inflation was 15%, Interest Rates were put up to 20% to get inflation under control by Paul Volker of the US Federal Reserve. Fighting Inflation is tough and needs to be done, but can be extremely painful for all concerned.

As I recall from my first day at work in 1979 at Barclays Bank International, the primary duty of a Central Bank was to protect the value of money. Inflation destroys the value of money. The destruction of the value of money ruins lives. Inflation is now making the poor in society even poorer. Those that can afford it, will buy real assets to store value

I am somewhat perplexed and disturbed by the US Federal Reserve. They are allowing the economy to run hot while continuing to stoke the fire. They are aided and abetted by the Biden Administration with its huge fiscal stimulus and infrastructure plans.
The stimulus was rightly introduced by the Fed to support the economy while waiting for the pandemic to end, and recovery to take place. Well looking at the PMI and ISM data the recovery has taken hold, now if the US Government would just stop paying people to stay home, unemployment rates would plummet.

The Fed said that high inflation is just a transition to getting the economy back to normality after the pandemic, as it’s just bottlenecks in the supply chain and labour shortages, inflation is temporary and nothing to worry about. Right?
The markets are buying into this narrative and happily buying stocks and bonds without seemingly a care in the World.

But will Inflation be just a transition? once the genie is out of the bottle it is tough to get it back in. The last time Fed policy was deemed to be wrong was when they were tightening between 2017 to 2019, interest rates went from 0.5% to 2.5%.
When they were thinking of going to 2.75% the market had a hissy fit, as did the then President Trump. The Fed did a somewhat embarrassing U-turn and started cutting rates. They were rewarded by higher stock markets, and praise from Trump.

Now, however, the ultra-low interest rate environment suits markets, so no dissenting voices are being heard, or those that complain are dismissed as doom-mongers, who don’t understand the temporary inflationary dynamics.

The Fed needs to start taking its foot off the accelerator and prime the market for a policy change. They are still pursuing an emergency stimulus policy for H1 2020, it is now nearly H2 2021. The argument that they need to wait for full employment is just plain silly.
Jolts have 8 million job vacancies, there is nothing wrong with the jobs market. It just needs people to go back to work, that will be happening soon as the welfare checks dry up. This is the last piece in the puzzle of economic normality.

If inflation proves to be not transitory and is left to run hot and higher, it will inevitably drive up the cost of borrowing threatening the recovery, and the stability of the market. In the past, all booms were followed by busts some soft, some hard landings. History needs to be remembered but not repeated. The tapering conversation should be on the agenda next week at the June FOMC, waiting for the Jackson Hole symposium to make a grand announcement is too long and a policy mistake.

Contact us at support@8dragonstrade.com

Published by Neil Callard

Forex Trader and Educator. 30 years trading experience, of which 20 years was market making in major currencies in large international financial institutions.

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