Where Do We Go From Here?

Turns out inflation isn't transitory and we are surrounded by it.  Whether its core inflation, wage push inflation or another variety under examination, the one thing we know is that the feds response will be data driven.


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Transcript

Where Do We Go From Here?
Season 2: Episode 1

 Ryan: Welcome back to the Real Spiel with Ryan and Kurt for our second season. Thank you so much for all of our listeners and subscribers. We're thrilled with the following that we've been able to garner in just twelve episodes. Took a couple months off through the summer and are ready to get back to it here. If you have any feedback or questions topics, you'd like us to cover. We'd love to hear from you reach out to us at therealspiel@USCFInvestments.com.

 It has been a couple months, things have kept pushing on. We'd like to refresh on inflation and real assets. We just got the 8.3% year over-year inflation print for August, and as expected, the Fed is increased rates by another 75 bps for the third time in a row and we have the market, anticipating another one and a quarter by year end through the remaining two Fed meetings. We've seen energy come down, food prices moderate, airfare and hotel prices come down, but inflation is still propped up. Is it just rents and rent equivalents, or what other factors are keeping inflation high Kurt?

 Kurt: Yeah. It's great to be here again with you Ryan, and I think one of the lessons that we should learn from all of this is that inflation is very hard to predict. We kind of knew this that we thought that inflation would be soft. Coming out of recovery from Covid, that supply chains would recover that we'd see ample supplies to meet demand and inflation would moderate. In fact, we were told this word transitory, which has been deleted from the Fed vocabulary.  I think if we go back even a prior decade Ryan, that we thought inflation would go the other way when we had the first quantitative easing and the acquisition of assets under the balance sheet at the Fed, the huge trillions of dollars that reprinted in response to the financial crisis. We thought that inflation had to happen. It was as if monetary phenomenon were printing trillions of dollars. Of course, inflation's gonna happen. And in fact, what we had was disinflation in the 2010s, lower and lower rates of inflation. Now what we have is assurances from the talking heads from the economists that we listened to in media and as well as from the Fed themselves don't worry about inflation it can be transitory, it’s all going to be okay. And it's not OK. So, I think one of the key lessons we can take away that inflation is very, very hard to predict.  What we have seen is a moderation in some key components of inflation. That's good news. So, we've seen the volatile sectors of food and energy moderate over the last, say, two to three months. Gasoline prices have gotten lower, you’ve probably seen that when you're filling up your tank at the pump, food prices have moderated a bit. And I think what was more troubling, though is that core inflation, what the Fed looks at even more closely has continued to keep going up. I think wages continued to be strong. Unemployment is still very low and I think wage push inflation is troublesome for the Fed, it is a  problem they have to address because as wages go higher people have more money to spend and labor becomes even more competitive so that you have to pay more up for the next you know marginal employee that you want to hire to convince him not to go to work for someone else. So a wage push inflation is something that the Fed wants to try to control and arrest if they can, but rent and rent equivalents, I think are also important high real estate prices, you know going back in over the last one, two, three years. Those are only going to be cycling into rent and rent equivalents over the next cycle. They're not fully there yet. I think there's going to be continued support for inflation coming there. I think the fact that the Fed has been forceful they’ve become more hawkish, they’ve made it really clear with their seventy-five basis point hike this week and their forecast for the remainder of ‘22 and forecast into ‘23. The fact that they have said we will do whatever it takes. That's a message that we've heard from the Fed before. And I think that they really don't have a choice. That's really the message they have to say, which is that we will bring inflation down. Whatever it takes and that might mean financial pain, more unemployment GDP slowdown and they're going to do it regardless. 

 Ryan: Yeah. Absolutely. We’ve also seen quantitative tightening toward the Fed was going from forty billion dollars rolling off their balance sheet a month up to ninety billion more recently. So, in addition to raising rates, you've got quantitative tightening. What needs to happen for inflation to come back down, though it seems like everyone's feeling the pain. What needs to happen?

 Kurt: So, there's a simple rule that I think is interesting called the Taylor rule named after an economist that worked for the Fed. And it's actually used by the Fed today and has been modified, as you can imagine something that was developed in the nineties has been modified and tweaked over time. But it still really is simple to understand. And it still an important policy tool that the Fed uses to try to set rates. The bad news is that essentially at the core, what you really need to do is have Fed rates. Interest-rate policy. Not just be equal to inflation but be roughly one and a half times inflation if the goal is to bring inflation lower. The flip side is that you can have rates be well below your target. If you're trying to be supportive and the Fed did that after the financial crisis, unfortunately the Fed can't take rates to minus three percent. They can bring them to zero. And then what the Fed did in response to the fact, they can't take rates lower than zero. They started buying assets and providing quantitative easing and other support, putting assets on the balance sheet. They are doing the inverse now. I think the bad news is the Fed is still, you know, below 4% as an overall, you know, kind of interest-rate level right now. You’ve seen expectations that rates will go higher by one year rate being over 4% now for the first time in in a long period of time. We're not there yet. As if inflation core inflation or general CPI kind of is sticky around this, you know, 6, 7, 8 percent level. The bad news is that and the Fed knows this. They have to take rates to 9, 10, 11 percent. If the goal is to bring it back down into a 2ish percent range. I think we're a long way from knowing where that will settle. In terms of where we're going to go from here. What I would say is, I think the Fed understands that their ability to forecast inflation is limited. And that includes you know our Treasury Secretary, Janet Yellen use to be chair of The Fed, these are very thoughtful, experienced people with hundreds of economists at their disposal. And yet, it's very hard to get a read on where inflation is going. They're going to be data driven. So, if inflation stays high, I think rates are gonna keep going higher until they feel they have it under control. The Fed has a very simple mission. They have two goals, full employment and maintaining inflation around an average two percent target. Full employment mission accomplished great job, I think full employment is considered anything where unemployment is five percent or less. And we're well below that. Inflation under control? missing that target big time. So, I think what we should expect from the Fed is higher rates until they see an impact in inflation that they feel confident about. And I think this confidence issue is really important for the Fed because the markets not only respond to what the Fed does but what the Fed messages. And if markets lose conviction that the Fed will do whatever it takes, take whatever steps it takes to rest inflation. Then it sort of gets out of control. So I think the hope from the administration in power right now, the Biden administration and from the Fed is that there will be conviction about what the Fed's doing and that inflation will start to moderate that supply chains will ease that prices for energy for food, for metals will moderate and the fear of the Fed will itself have an impact on expectations of inflation. So they won't have to go as far. Maybe they will hike into ‘23 and then it can start to ease off or stop to continue to hike. But what I will tell you is that if they see rates going higher in ‘23, if we see whether it’s because of global conflict in Ukraine, climate change, other issues. If they keep seeing higher rates, sorry higher rates of inflation, if we continue to see the higher commodity prices, if you see rent and rent equivalents continue to go up, the Fed is going do exactly what they're doing right now. They're going to keep hiking at these high interval levels until they see that that reaction. 

 Ryan: Well. Yeah. So, buckle in and I'm sure have many updates coming in the upcoming months again. Thank you to all our listeners. We'd love to hear from you. therealspiel@USCFInvestments.com and we will talk to you next week.