The Big Escape
A macro QE programme status quo analysis
The Big Escape
By N2 Labs (Ltd) June 20, 2022
(in Auckland, New Zealand)
“He backed himself into a corner with an army of mythical creatures with advanced weaponry charging down on him from every direction. There is no easy way out, really there is only one way out to salvage himself. Through the nearest sewerage pipe…”. That last bit is appetite killing I agree, and no, this isn’t an excerpt from an unpublished draft from Marvel’s next comic series.
This is how a movie scene from “The Big Escape, (Fed Flavor)” would’ve looked like if there was ever to be one. The Federal Reserve (Fed) is currently at war with raging inflation albeit at the seemingly losing end for now, Fed Chair Jerome Powell remains confident there is a way out.
Powell has not just one but two jobs at hand. One of them, regaining fast depleting Fed credibility with the public & other being reining back in price stability/inflation down to neutral targets. After stubbornly sticking to the transitory inflation narrative for most of 2021, the term ‘transitory’ was finally retired. Much of the damage however, had already been done. At the epitome of public distrust of transitory narrative, Powell was all over WallStreetBets memes.
Even human psychology is stacked up against them, as humans tend to remember recent events better than older ones & quite frankly, recently these humans have been burnt, burnt by inflation caused by Fed not moving quicker and falling behind the curve to bring money supply & velocity down. So who can blame the public for being twice shy in trusting Fed’s forward guidance this time around.
Fed’s job now is to orchestrate the monetary tools and engineer a decent landing. Whether they will succeed is yet to be seen. There is a new narrative that a soft landing is quite possible, it’s hard to see how. If the Fed manages to bring inflation down without inducing a recession, Powell will no doubt end up in Fed’s hall of fame & honestly, none of us would mind that as that would be the best outcome of all scenarios possible.
I wouldn’t hold my breath just for now, with bond yields starting to fall and ISM index (Institute of Supply Management) heading back to 40 to 50 range. There is enough data pointing to a recession if we aren’t already in one at the time of this article (June, 2022) regardless of what the last GDP readings say. A sharp but quick U-turning recession remains to be the best outcome, if it manages to dampen demand end & cause a sharp fall in price levels. Unfortunately when it comes to supply end, even the Fed is helpless as their tools stop having any impact past demand in the supply demand equation. Maybe fiscal policies can have a stronger impact there but that’d be a write up for another day.
There is no doubt energy price shocks have contributed to a greater degree towards sky high real inflation numbers. A demand destructing recession might be just what the doctor ordered here as that should alleviate heavy burden from the energy component over the inflation index. It’ll however be a tricky play as one wrong move & this whole thing could go haywire in the blink of an eye if stagflation takes over from its closer sibling, inflation. An induced recession causing high unemployment while failing to dial down inflation will put the Fed in a major dilemma, a reverberating policy mistake that could affect all walks of life.
Effects of this situation could be further exacerbated by where we are in the long term debt cycle. If central banks had to tighten into a stagflationary environment while worlds neck deep in parabolic debt levels, you might not want to know what could follow. I don’t even want to mention the D word here. It remains a highly unlikely scenario that central banks would allow their own policies to cause an ugly depression, my money would be on further debt devaluation via denominator debasement at first signs of an economic depression.
Of course this a nuanced take on the status quo, there are plenty more levers & variables that needs to be accounted for (e.g. external geo-political events that could unwind to surprise & blind side the major central banks including the Fed) but for now, lets just hope the central banks can load their monetary bazookas for another round of easing when required while bringing down the inflation bull asap.
Disclaimer