Powell: Higher for Longer than You Can Imagine

 There is this constant argument that Jerome Powell (can I call you Jay?) is somehow going to pause after the next rate hike, and then begin to cut rates in the late spring or summer because the economy will soften and inflation will have returned to the Fed’s target range. 

Bottom line up front: I think that view is completely wrongheaded.

Rates will be higher for longer. The median Fed funds rate is expected to average 5.1% in 2023!

“'Changing our inflation goal is just something we’re not—we’re not thinking about and it’s not something we're going to think about. It’s—it—we have a two percent inflation goal, and we'll use our tools to get inflation back to two percent. 

I think this isn’t the time to be thinking about that. I mean there may be a longer-run project at some point but that is not where we are at all. The committee—we’re not considering that, we’re not going to consider that under any circumstances. We’re going to—we’re going to keep our inflation target at two percent and we're going to use our tools to get inflation back to two percent.’”

There is a quiet conversation in upper academic and economic policy levels that looks at the debt and thinks 4% inflation is what we need. 

This of course will slow the economy down but what if we are going to run deficits? They were worried back then US government debt was getting too high. Since debt is nominal, 4% inflation cuts it in half in 18 years.  

Sea Change

One of my favorite analysts is Howard Marks of Oaktree Capital. I read his quarterly letters quasi-religiously, generally 2‒3 times or more. His latest is one of his best. I am going to summarize a little and quote some, but you can read the full letter here. 

https://www.oaktreecapital.com/docs/default-source/memos/sea-change.pdf

“In my 53 years in the investment world, I’ve seen a number of economic cycles, pendulum swings, manias and panics, bubbles and crashes, but I remember only two real sea changes. I think we may be in the midst of a third one today.”

The first change he vividly describes was the creation of high-yield bonds and an increased appetite for balanced risk. 

Prior to Milken, et al., bonds rated below B weren’t considered investable. The only way a company could acquire another company was for cash or by borrowing, but borrowing was limited to the amount you could get without changing your rating.

The second sea change was Volcker’s breaking of inflation and then the beginning of a 40-year bond bull market.

But that brings us to where we were in 2020. Quoting Howard Marks again: ...

I highly suggest you read it but the conclusion is we’re not going back to ultra-low rates, barring a severe recession.

Let’s pause to think about that. Financial repression by central banks all over the developed world forced retirees, pension funds, endowments, etc. to take increased risks or miss their investment targets.

John Mauldin 16 December 2022

https://www.mauldineconomics.com/frontlinethoughts/higher-for-longer