The Rising Influence of Rising Affluence

[10nisman]

Do you wholly reject Jeremy Siegel's viewpoint (#msg-170041401)? TIA

Let's look at what has transpired.

We had a very bad shock to the financial system in March 2020 due to fears of the pandemic and financial markets largely seized. Fed comes in and saves the day with unprecedented monetary stimulus (massive QE, cuts rates, etc.) and is a hero. Fed enjoys the fact that they saved the day, seeing the financial system and markets stabilize, and it decides to have some celebratory drinks. A few drinks turns into a year long boondoggle... They awake from their drunken stupor, look around and see an economy opened back up / Americans spending, solid job / wage gains, and real GDP growth; but, they also notice severe global supply chain shocks driving up prices for most goods, as well as, new COVID variants that are having unpredictable impacts on the economy. The Fed assesses the situation and comes to the conclusion there are two likely outcomes --- (1) Global supply chains and the economy continues to improve over the next 12 months, or (2) Global supply chains don't improve and/or COVID variants lead to economic shutdowns, etc., and there is significant risk to the economy. Considering these potential outcomes, the Fed believes accommodative policy makes the most sense to continue. And then the unforeseen macro event takes place... Russia begins to deploy troops around Ukraine in late 2021 kicking off the war in 2022 and a major inflation wave, and the Fed and its accommodative policy are screwed.

Given the above, what should the Fed do? Stay the course, raise rates, or go back to drinking. The Fed assessed the situation and said, if this war doesn't end in short-order, we will need to change policy and severely including raising rates significantly but in a manner that is digestible by the financial system. So, they raise rates by 25 bps in March 2022, 50 bps in May 2022 and outline launching QT, followed by the most recent three 75 bps hikes (June 2022, July 2022 and September 2022). In a perfect world, the Fed would have raised rates by 200 bps in March 2022, however, it would have broken the financial system.

Prof Siegel's issue with the Fed is it moved rates too high to fast and will cause a severe recession and he cites lower commodity prices (oil, lumber, etc.) as signs that inflation has peaked and is coming down significantly. Inflation peaking and commodity prices coming down is great news and the Fed is thankful for that.
However, the Fed is concerned about getting inflation back to 2% not the current 4-6%, and it's only real tool to do such (while trying to make up for lost time since it had to slowly increase rates) is to raise rates quickly and swiftly before inflation expectations become embedded in business / employee forecasts.

The Fed knows it's actions will likely cause higher unemployment (it's actually hoping it does) (i.e., the words "there will be PAIN") and likely a recession. However, the alternative (sticky 4+% inflation for as long as the eye can see), has far worse consequences for the average American than a recession. Thus, the Fed is taking its medicine and chipping back into into the fairway and accepting the likely bogey for its errant tee-shot vs. trying a billion and one shot of going for the green through thick forest to try and save par with a high likelihood of a much worse outcome (triple bogey).

People have every right to be mad at the Fed for their lack of action in 2021, although, very few people were complaining about their lack of action back then. However, I don't see how anyone can fault them for their actions today. The Fed doesn't have the ability to increase supply of goods by building refineries, factories, etc., and thus, its using the tools provided to try and reign in inflation quickly.

Prof Siegel is a very smart guy, however, the only suggestion he has is for the Fed to pause / do nothing and hope inflation goes away by itself? If the Fed stopped its rate hiking regime like Prof Siegel wants, there's a decent likelihood asset prices move back up (possibly significantly) and as a result, inflation not only doesn't decline further but reaccelerates. Then what happens? The Fed needs to move rates even higher than it would have otherwise... This sounds very similar to what happened many decades ago.