A few days ago, we playfully suggested that the Federal Reserve had conquered inflation based on a historical analysis of CPI inflation from 1972 to 1976. However, this conclusion proved shortsighted, as the late 1970s and early 1980s witnessed a surge in inflation, with Paul Volcker resorting to drastic measures, including raising interest rates to 20%, to tame it.
Now, with the Federal Reserve signaling a shift despite core inflation hovering around 4.00%, double the Fed's long-term target, questions arise about whether history will repeat itself. According to a recent report by Jared Woodard, heading the Research Investment Committee at Bank of America, the Fed's upcoming cuts might inadvertently fuel structural inflation. Woodard points to resilient sectors in the economy that appear immune to rate hikes: substantial government deficits, elevated household savings, rising wages, record home prices, and corporations cushioned by private credit and cash.
The report issues a warning that the Fed's unexpected pivot on December 13 may have set the stage for more severe inflation in the future.
The most recent tightening cycle implemented by the Fed managed to slow inflation this year, and predictions suggest further easing of price pressures in 2024. However, concerns persist about the potential for structurally higher inflation due to historically tight labor and commodity markets.
The report delves into various factors indicating potential challenges in curbing inflation. It suggests that premature or aggressive Fed cuts could reignite price pressures, outlining seven key variables across government, household, and corporate sectors that are being monitored to assess progress in disinflation.
In terms of government spending, the report highlights the Fed's limited influence, emphasizing that congressional actions, particularly high deficits, may offset the intended tightening effects of Fed hikes. Government deficits are currently at their widest outside of a recession, with a significant portion of spending considered politically untouchable.
The report also underscores the resilience of households, noting that Fed hikes have yet to impact them significantly. Factors such as low mortgage rates, strong wage growth, and government spending have kept the economy robust, with consumers accumulating record levels of cash.
Corporate balance sheets are portrayed as strong, with ample cash reserves and private markets providing crucial support to credit markets. The report suggests that corporate dry powder and strong balance sheets contribute to easier financial conditions, potentially mitigating the impact of Fed hikes.
In conclusion, the report raises concerns about the potential for the Fed's actions to reignite stagflationary forces in 2024, emphasizing the importance of inflation hedges for investors seeking balanced portfolios.
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