What, Me Worry?

The Federal Open Market Committee (FOMC) held their meeting this week and as usual, it created some wild swings on Wall Street. What caused the ruckus this time was a market that had been leaning toward fewer and fewer rates cuts and some early chatter about maybe the next move had to be an increase because inflation was increasingly sticky. That sticky inflation was causing many of us old timers to consider stagflation as a possible outcome, which is something the U.S. has not seen since the late 70’s/early 80’s. (A recent World Bank report defined stagflation as a combination of high inflation and low growth or high unemployment.)

What set the market rising was Powell’s comment at the press conference that discounted stagflation. “I was around for stagflation and it was 10 percent unemployment, it was high single digits inflation, right now we have… 3 percent growth, which is pretty solid growth I would say, by any measure, and we have inflation running under 3 percent. So, I don’t really understand where that’s coming from… so I don’t see the ‘stag’ or the ‘flation’ actually.” His message was loud and clear…. I’m not worried.

Financial markets often overreact to news and we suspect they did once again. Chair Powell is absolutely correct that the current situation has little resemblance to the 1970’s, we would counter that stagflation does not need to look like the 1970’s either. Below trend growth and above trend inflation would fit our definition. At the moment, we are NOT there, but recent data has brought us stickier than expected inflation and some evidence of slowing growth. That raises the level of concern, even if it is not a base case for the economy.

Many would argue who are we to question some of the brightest economists on the planet and that is a valid argument. Our counter is that these same economists missed the inflation in the first place and then reacted to it very slowly, which has brought us to the difficult economic situation we have today. The Fed’s job is not easy, even for the best and the brightest. Nonetheless, markets will move with the Fed simply because traders are now convinced that not only is a rate increase off the table, at least for now, but that implies rate cuts are still coming. As we have said before, we look for the rates to be ‘lower, but slower’. For now, that is all the stock market needs to renew a rally.

Have a great week!

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By: thinkhouse