Sometimes there are seismic shifts in fundamental financial and economic policy that go completely unnoticed by the media. We might just have had one of those. The question of the day is: “has the Fed given up on the 2% inflation target?”
It looks like the Fed is gently backpedaling away from that 2% target. I’ve talked about this probably for the last two years, that I wouldn’t be surprised that all of this happened. And finally, we’re getting something that’s going to look more like 2 to 3%. That’s a big difference. In fact, the most recent numbers show an upward revision of inflation expectations, and yet the Fed is talking about possibly lowering interest rates two to three times this year. So what’s going on? Why the dovish tilt in the face of rising expectations?
Now, we’ve talked about a Goldilocks economy a number of times in the last year. Unemployment is almost close to historical lows, economic growth is healthy, the economy is running on all eight cylinders. So why open the spigot a little bit? Why slow down the buyback of all the money that was put into the system post-COVID? And it’s not just the Fed. The Bank of Japan is doing this. The Swiss National Bank is doing this, and a lot of other countries are looking at it, too.
We talked about one supply constraint being a slowdown in global trade. And global trade, that global competition, puts a cap on price rises. Global trade with tariffs, those tariffs aren’t paid by manufacturers, they’re paid by consumers. So when we slap a 25% tariff on Chinese goods, pretty much within two to three years, that 25% tariff is going to show up in the price of those goods.
The third element is there’s been a huge demographic shortfall that’s really beginning to hit us hard. The birth rate in the United States, which is arguably one of the highest in the Western world, is below replacement rate. We have the baby boomers slowly phasing out of the workforce. There just aren’t enough people to go around. We need immigrants. We need skilled immigrants. We need unskilled immigrants. But that’s a toxic topic. And because of that, the politicians, they don’t want to deal with that. And I understand. If you’re trying to survive in the electoral environment, you have to think about these things.
But this means the Fed has to loosen things up. And as I said, it’s a Western phenomenon, not just a US phenomenon. So what’s going on is we’re moving from that 2% targeting to the 2 to 3% targeting that I think we’ve talked about a number of times in previous videos.
There’s another beneficiary to this and that is the treasury itself. At 3% inflation, the debt is monetized by a reduction in half every 20 years. And when we’re talking about the timeline of these huge fiscal debts, 20 years isn’t that long. And 50% is an awful big number. So there’s a lot of reasons to expect to not see 2% inflation anytime soon, maybe not in our lifetime.
It’s also, this case we make, not all bad. How will inflation affect your investments, your portfolio? Give us a call. We wish you the best of investment success.
Sources
- US inflation rises to 2.5%, according to Fed’s target index (ft.com)
- A turning point in central banking (ft.com)
- Illustration by Sebastien Thibault
