The Real Inflation Problem
With Janet Yellen having raised the Fed Funds rate a fourth time last week to a target range of 1.0% - 1.25%, there is/has been an awful lot of talk about inflation. In fact, the current annualized level of inflation (~2%) is being used as justification for the Fed's plan to return rates and monetary policy to more "normalized" levels.
However, in my opinion, all this talk about inflation is borderline comical and likely just a smoke screen for the Fed's primary objective - keeping the economy moving forward and out of the deflationary ditch.
The problem is that the Fed's official mandate doesn't include keeping GDP growing at a healthy clip. No, the only two tasks the country's merry band of central bankers have are (1) full employment and (2) stable prices (i.e. low inflation). As such, during the aftermath of the Great Recession, Ben Bernanke and Janet Yellen have been forced to dance around the idea of equating 2% inflation with an acceptable level of economic growth.
Inflation Is Too What?
I grew up in this business in the 1980's. To be sure, this was a time when investors feared inflation. I was there when Paul Volcker declared war on inflation. The investing industry then spent the next 20+ years worrying that the bad old days of runaway inflation would return. So, pardon me if I find the current fixation on getting inflation back "up" to an acceptable level a little amusing.
Why doesn't Yellen & Co. just come out and say it; "Hey, our real job is to make sure the economy is heading in the right direction." And then while we're at it, perhaps the purchasing power of the U.S. dollar should be brought into the mix as well. After all, the state of the greenback is surely a topic of discussion at the occasional Fed meeting, right?
But alas, the U.S. Federal Reserve is stuck trying to keep the largest, most complex economy in the world rolling down the track by focusing on two simple targets: unemployment and inflation.
The key point here (yes, I promise there IS a point coming) is that inflation and inflation expectations are currently trending lower - and have been for the better part of this year. Therefore, raising rates when inflation expectations are in decline would seem to be counterintuitive. Hence my reference to all the talk about inflation being a smoke screen.
Yes, it is true that inflation - according to the Fed's preferred measures - is currently at or slightly above the 2% target. Yet, it is important to recognize that these measures tend to be a bit "rear view mirror" oriented and the more forward-looking inflation metrics are currently moving down and to the right.
So, why then is Yellen fixated on raising rates in such an environment? In short, because it is time for the Fed to get out of the way - and they know it!
In reality, the economy has been strong enough for the Fed to remove the low-rate life support for some time. But due to the silly focus on an acceptable level of inflation, which remained stubbornly low for years, the Fed has wound up with some unintended consequences.
The Law Of Unintended Consequences
You remember the economic version of the law of unintended consequences, don't you?
Almost everyone agrees that Alan Greenspan's decision to keep rates too low for too long basically created the mortgage/housing/credit crisis (aka the Great Recession of 2008), which, in turn, led to the worst economic downturn seen in the U.S. since the Great Depression.
So, with rates having been kept at generational lows for nearly a decade now, you can bet dollars to doughnuts that the Fed is likely worried - at least a little - about a repeat and/or the next bubble-induced debacle.
Although bubbles don't tend to occur when everyone is looking for them, one of the unintended consequences of the Fed's scheme to get inflation back to their 2% target has been the explosion of student loan debt.
While the official measure of inflation (which is reconfigured from time to time in order to make sure the government can afford to pay those pesky inflation adjustments tied to entitlement programs) has stagnated for nearly a decade, the cost of sending junior to college skyrocketed. And along with the rising cost of college came a massive steaming heap of student loan debt.
The cost of college just kept going up every year because the cost of financing it kept falling. Forget that CPI was uber low for years, college costs kept rising 5%, 6%, and more, year after year. And before you knew it, there was more student loan debt in this country than mortgage debt. Yes, even AFTER the binge of home buying in the mid-2000's!
The key point is one of the unintended consequences of rates being kept too low for too long is that student loans will now become a macro drag on the economy. Yep, that's right, instead of your sons and daughters buying cars, TV's, washing machines, and taking vacations after they've graduated college and gotten a job, now they get to pay off that $30,000 - $50,000 loan.
From a macro point of view, the massive amount of student loan debt means lower economic growth for a very long time - perhaps even a decade or two.
So, from my seat, this is at least part of the reason why Ms. Yellen is ignoring the downtrend in inflation expectations and using the magical 2% target in PCE to justify the Fed stepping away. Something that probably should have happened years ago - if the Fed were allowed to focus on the stuff that matters, that is.
Thought For The Day:
Remember, you can choose to enter a peaceful mode at any point of any day...
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can both identify and understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of the U.S. Economy
2. The State of Earning Growth
3. The State of Trump Administration Policies
Wishing you green screens and all the best for a great day,
David D. Moenning
Chief Investment Officer
Sowell Management Services
Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.
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