Rudi’s View: Don’t Fight The Fed

Always an independent thinker, Rudi has not shied away from making big out-of-consensus predictions that proved accurate later on. When Rio Tinto shares surged above $120 he wrote investors should sell. In mid-2008 he warned investors not to hold on to equities in oil producers. In August 2008 he predicted the largest sell-off in commodities stocks was about to follow. In 2009 he suggested Australian banks were an excellent buy. Between 2011 and 2015 Rudi consistently maintained investors were better off avoiding exposure to commodities and to commodities stocks. Post GFC, he dedicated his research to finding All-Weather Performers. See also "All-Weather Performers" on this website, as well as the Special Reports section.

Rudi's View | May 26 2022

In this week's Weekly Insights:

-Don't Fight The Fed
-Beware The Bear!
-The Quote
-Conviction Calls
-Rudi Talks
-Recent Weekly Insights To (Re)Read

By Rudi Filapek-Vandyck, Editor FNArena

Don't Fight The Fed

One of the defining events for global finance in 2022 happened during the Wall Street Journal Future of Everything Festival at which Fed Chair Jerome Powell spoke on May 17 and -finally!- got the message out the world's most powerful central bank is now singularly focused on bringing inflation down towards 2% (from 8%-plus).

His admission this would not be possible without causing some pain, including the unemployment rate rising, would have rattled a few, but that was the explicit intention.

For many years investors have relied on the Federal Reserve to bail them out when markets showed their vulnerability and proved at risk of breaking down. With the 2020 experience still fresh in mind, many an investor the world around has become used to the fact that buying-the-dip is a simple but highly effective strategy.

Now the Fed is no longer aiming to prop up the economy through rising financial assets, and thus attitudes towards risk-taking and spending need to change. Across the USA, but preferably including the rest of the world too.

While inflation is stuck in between ongoing covid restrictions and supply-side disruptions and challenges, with the Russia-Ukraine war adding its own twist, the only way to tame inflation is thus by reducing demand. And in order to reduce demand, consumers need to become less comfortable with their financial situation and prospects.

Central banks have no control over global supply chains, but they wield enormous leverage over credit and financial assets. Bringing down asset values, and thus make consumers feel a lot less comfortable, seems but the most logical policy aim to pursue in 2022.

The exposure of US households to US equities has never been greater. Plus add a whole new generation of young "investors" who don't genuinely know the practical implication of 'risk' and believe, with conviction, that owning crypto-currencies and NFTs is the quickest route to becoming a billionaire before celebrating their 30th birthday.

In Australia, a similar observation can be made about a general perception that housing prices never fall, mate.

The Federal Reserve needs to change all of that in order to successfully rein in what it had mistakenly considered as a temporary, "transitory" phenomenon throughout 2021. For the record: it is still possible inflation post-2020 might prove transitory on many accounts, but central bankers can no longer afford the luxury of sticking with a wait-and-see approach.

The risk of inflation becoming embedded is simply too high and would be many times over more damaging than the pain inflicted through an aggressive path of tightening. The Fed is all too aware of this. Note, for example, how Powell himself has recently started to include references to Paul Volcker, the central banker widely credited with slaying the inflation dragon in the early 1980s.

The Volcker Fed's aggressive tightening caused two economic recessions at the time, but it did pull down high inflation to manageable levels.

The message Powell has been trying to get across is that today's Federal Reserve is just as determined to put inflation back in its bottle. However, after more than a decade of explicit central bank support for financial assets in order to stave off structural deflation, most investors still have failed to comprehend the deeper meaning of the change in central bank messaging.

We know what to do, and we know how to do it, Powell declared at the WSJ Festival, adding there should be no doubt, the Fed will do what is necessary. "What we need to see is inflation coming down in a clear and convincing way, and we’re going to keep pushing until we see that"- those were his exact words.

Judging from price action since, it appears markets have finally understood the old saying of 'Don't Fight The Fed' now has a different meaning. The Fed wants less risk-taking, less confidence and less spending. Jobs will be lost. Asset prices will come down. But it's the pain that needs to happen, because inflation is a much, much bigger threat to everybody's wealth and future prospects.

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