“The blunders are all there on the board, waiting to be made.”
— Savielly Tartakower, Chess Grandmaster
Poor Jerome Powell…
When the pandemic shutdowns sent the stock market tumbling, the Federal Reserve Chairman presided over a series of actions he thought were best proscribed — he and the governors agreed to cut interest rates and purchase assets to keep the system going.
But all that money flooding in created speculative asset bubbles. Then it overflowed into the economy at large, creating the kind of inflation we haven’t had since Carter took a vacation from his peanut farm for four years. The kind of inflation the Fed is supposed to keep in check. The kind of inflation that reminds you prime rib is a commodity.
Today we learned that the inflation rate topped 7.9% in February — its highest single increase in 40 years.
We recall the warning former Fed Chairman Paul Volcker gave us for I.O.U.S.A.: “Don’t let inflation get started, because once it gets some momentum, it’s very difficult to deal with.”
Volcker famously fought inflation in the early 1980s by drastically boosting interest rates. We doubt the current Chairman would dare to be so bold. Nor will he necessarily…
Still, Powell has to do something. And as Jim Rickards told us in our Session a few weeks back, the Fed can’t be coy about it. “Just think of the Fed as an institution that never wants to surprise anybody,” he said.
So Fed officials have spent the last few weeks warning anyone who would listen. “Rate hikes are coming,” has been the refrain. “We’re paring back asset purchases, too.”
Investors seemed to be taking the news in stride. The economy was strong enough to thrive without the Fed’s inflows of cash. Businesses could absorb the added costs of borrowing money with more interest. Sure, car loans and mortgages would get more expensive… but so what?
It didn’t make sense… and we’ve been saying that things will quickly go sideways when the Fed does the deed.
Then Russia invaded Ukraine.
The news sent already-tempestuous energy prices even higher. Worries about supply chains surged as Wall Street remembered how much of the world’s raw materials come from Russian mines. There are very real fears that the United States could be dragged into a shooting war — to say nothing of all the things that could happen when a pair of nuclear superpowers start duking it out.
The major stock indexes have been in major decline as a result. Unless Vladimir Putin has a sudden change of heart, the invasion will still be top of mind when the Fed’s Open Market Committee meets next week.
What will the Fed do? The inflation rate demands action… and investors have been conditioned to expect a hike. But the situation in Eastern Europe is causing economic instability — the kind the Fed usually fights with loose money.
The Germans actually have a word for this situation — “Zugzwang,” roughly translated as “compelled to move.”
It’s used in chess when all of a player’s available choices will put them in a worse position.
Next week’s meeting could start the endgame for the bubble economy… starting Wall Street on a path towards inevitable checkmate.
Follow your bliss,
Founder, The Financial Reserve