The Rundown
Yesterday, (Monday, June 13th), we saw a very bloody day in the market. The Dow finished -2.79%, S&P 500 finished -3.88%, and NASDAQ finished -4.68%. Everyone’s portfolio was devastated, and there are signs that this will continue.
On June 14-15, which is today through tomorrow, the Federal Reserve’s FOMC will meet to determine the next steps to take in order to curb rising inflation. It was widely expected that we would see 50 basis point hikes in June and July, followed by a 25 basis point hike in September. This has changed, as the market is now expecting 75 basis points in June and July, along with 50 basis points in September. With the baseline rate currently at 0.75%, these potential hikes would give us a baseline rate of 2.75% by the end of September. This is much quicker than the pace we expected early in 2022.
In the June meeting this week we are also expecting the Summary of Economic Projections, which will tell us more about what the Federal Reserve thinks about the future of the economy, and what their plans are for rate hikes for the rest of the year. I will report back on this on Thursday.
The Problem
The problem we are facing is a multi-leveled challenge. The baseline level is we printed too much money in an attempt to keep the economy from crashing during Covid. The only reason we can say this is becaue hinesight is 20/20. Layer 2 is the supply chain issues we saw due to the initial Covid shutdowns. This greatly delayed many areas of production, giving us the increase in many commodities, leading to many massive price increases. The 3rd layer was the first wave of Delta, causing even shutdowns and more delays in the supply chain. The 4th layer comes after we thought we were out of the clear of Delta, and that is Omicron. This caused another layer of delays and even more supply chain issues. The 5th layer are the continued Chinese shutdowns, once again adding more strain to the supply chain. The icing on the cake is the Russia and Ukraine War, causing a massive spike in oil, wheat, and many other commodities, and fears that we will have a worldwide famine this fall.
And in comes Jerome Powell, Chair of the Federal Reserve, and the Federal Open Market Committee. All they can do to solve this issue is raise interest rates and tighten the money supply. Quite literally the whole world is watching and waiting to see what they are going to do, and their words have massive impacts on all markets.
The (Potential) Solution
The man pictured above is Paul Volcker, former Federal Reserve Chair, the same job as current Fed chair Jerome Powell. Paul Volcker was the Fed Chair from 1979-1987. In 1979 when Paul Volcker took office as Fed Chair, the inflation rate was 13.3%, even after a long decade of massive inflation. To get this down, Paul Volcker believed it was necessary to raise interest rates above the rate of inflation in order to bring the rate of inflation down.
So he did.
In October 1979, Paul Volcker and the Federal Reserve raised interest rates to almost 20% in an effort to bring down inflation. This worked, but at a cost. This massive rate increase in the year to come did bring down inflation, but with it pushed the economy into a severe recession, with massive job loss, no liquidity in markets, and what proved to be a painful recession. Unemployment peaked at 10.8%, but inflation finally fell to 3.7% in the early 80’s.
The potential solution here would be to do something similar to what Paul Volcker did in 1979, shock markets and raise interest rates much higher than expected. Of course in today’s economy, 20% is not pheasible, but we need the same measure. It is becoming increasingly obvious that inflation will not go away on its own, and at some point we must ask ourselves if it is worth suffering years of high inflation, or a short term recession to bring down inflation.
In my opinion, whether we have years of inflation or not, the end result of a nasty recession is inevitable. Because of this, I believe it would be appropriate for the Federal Reserve to raise rates 100 basis points at the next three meetings, much higher than market expectations, bringing us to 3.75% at the end of September, in order to help bring down inflation. After September, we will have FOMC meetings in November and December, giving us the opportunity to hit 5% by end of year. Regardless, I believe whether it’s one of these upcoming meetings or one later in the year, we are going to see serious and legitimate action from the Federal Reserve in an attempt to bring down inflation.