Asset Strategy, Market Insights, Market News

What Does the Fed Really Think About Inflation?

Gold Alliance disclaimer

We all notice inflation and rising prices when we go to the supermarket, buy a car, or receive a construction bid to repair something in our home.

Inflation is here, so it takes a lot of gall to lie to the entire American population and say that inflation isn’t severe or that it will go away… but the Fed is telling us they aren’t concerned. 

Outside of the central bank, however, economists are warning that we should be concerned — that the rising inflation isn’t transitory. Mohamed El-Erian (President of Queens’ College, Cambridge, and Chief Economic Adviser at Allianz) argues that too much confidence is placed in the view that inflation rises will be transitory:

El-Erian says that “seemingly one-off increases in prices can cascade through the system” and that “a rise in inflation can be persistent, starting with commodities and prices at the factory gate only to end up in consumer prices and wages.”

He warns that the Fed “is likely to be very late in adjusting strategy should its transitory inflation call not materialise. A late slamming of the brakes, rather than an earlier easing off the accelerator, would significantly increase the risk of an unnecessary economic recession.”

Nouriel Roubini (Professor at the Stern School of Business, New York University) goes even further, saying that we could see a repeat of the 1970s:

“Today’s extremely loose monetary and fiscal policies, when combined with a number of negative supply shocks, could result in 1970s-style stagflation (high inflation alongside a recession).”

That’s far from the Fed’s “inflation is transitory.”

So as we continue to watch inflation rise, the Fed waves away investor and consumer concerns while trying to convince us we should have confidence in its ability to control inflation and prevent the insanely overvalued stock market (based on every historical matrix) from crashing.

Let’s start with the latter.

Will the stock market crash in 2021?

Experts are saying that the stock market is due for a correction. Although they are debating the timing of the correction, they are saying one thing is nearly certain: A significant correction is on its way. 

Let’s face it, we’ve been in a post-Covid upswing for over a year now, but it’s clear that a lot of the money getting pumped into the overvalued market isn’t productive (a lot of it is coming from corporations’ stock buybacks with borrowed money, driving up their own stock prices). In other words, the rapid growth in stock prices isn’t reflected by growth in GDP or actual added value to the companies. Hence the use of the word “overvalued.”

How will inflation affect the stock market?

Inflation is considered one of the driving factors that could actually crash the stock market. The most likely reason for this will come in the form of soaring inflation expectations that could lead to the Fed ending or significantly tapering its monetary interventions as well as tightening its monetary policies. 

The markets have grown used to these “accommodations,” so if there’s even a hint that the Fed will actually tighten its policies, the markets aren’t going to roll out the red carpet and welcome it with open arms.

Let’s recap what the Fed committed to on their emergency meeting back in March 2020:

  1. Make its quantitative easing (QE) programs “unlimited” to remove any limits on money printing and asset purchases.
  2. Expand its QE programs from buying US Treasuries and mortgage-backed securities to including corporate debt, debt issued by corporations, corporate debt–related ETFs, and municipal debt.
  3. Expand its Money Market QE to include a wider range of securities, such as CDs (certificates of deposits).
  4. Expand its commercial paper (a common form of unsecured, short-term debt issued by a corporation) QE program.
  5. Create a new QE program to purchase any asset-backed securities, including student debt.
  6. Begin a bailout program for small- and medium-sized companies.
  7. Lower the repo interest rate to zero (repurchase agreements — repos — are a form of short-term borrowing for dealers in government securities).

These programs led to over $3 trillion being printed in just four months (March–July 2020), and another nearly $700 billion have been printed since then. Cash is like water. It does not spread evenly. Rather, it pools. As a result of these tremendous amounts being pumped into the economy, the cash pooled in the stock market, and stocks hit all-time highs within six months of the March 2020 market meltdown.

All the excess cash also pooled into the real estate markets, groceries, everything… causing inflation. But now that inflation has made a comeback, the central bank has very little room left to maneuver because any action to counter inflation could upset the markets and derail the economic recovery. So, to buy time, the Fed is claiming inflation is temporary when, in reality, even its own members don’t agree with this position. 

What Fed officials say about inflation

Several Fed officials, including Patrick Harker (President, Philadelphia Fed), Robert Kaplan (President, Dallas Fed), and Loretta Mester (President, Cleveland Fed) are breaking with the central bank’s official statements. They’re suggesting the Fed should consider tapering its QE programs or tightening its monetary policies.

And we learned from the Federal Open Market Committee’s April meeting that a number of officials were discussing the need to dial back the Fed’s measures because of inflation pressures:

“…a couple of participants commented on the risks of inflation pressures building up to unwelcome levels before they become sufficiently evident to induce a policy reaction.”

These are just comments by a minority of Fed officials, but they show that, internally, the need to address inflation is on the Fed’s radar.

The Fed’s trying to buy time

April inflation numbers came in at 4.2% as the Fed dismissed inflation concerns. May’s numbers show that inflation has now risen to 5%, but the Fed is maintaining its policies. Five percent inflation means that your purchasing power from your salary or fixed income revenue will be reduced by 5% this year.

At what point will the central bank admit publicly what it already acknowledges internally — that inflation is in fact here? Hopefully sooner than later. Once inflation manifests itself, it could accelerate because consumers, for instance, come to expect inflation, which in itself is enough to push inflation higher.

So, the Fed is 100% aware that inflation is becoming a concern for consumers, businesses, and investors. But in order to fight inflation, the central bank will need to pump the breaks on its QE. And since stocks depend so heavily on these QE programs, dialing them back opens the door to a significant market correction and would affect Main Street as well. 

The Fed is stuck between fighting inflation and keeping the stock market bull run going. It’s aware of the significant impact of its decisions, which is why it’s trying to buy time. Eventually, it will have to act on inflation, but for now, it’s sticking to its false narrative.

And this is why gold provides financial security. Gold investors will look at both of those scenarios with peace of mind. Historically, the gold part of their portfolio will protect them from a market crash and inflation. 

Why would you want to lose sleep by putting all your eggs in markets that depend on the Fed to keep their value?

About Fred Abadi

In his over 15 years in the financial industry, Fred has focused on commodities and precious metals as investment assets. He has penned several articles on topics such as the commodities markets and investing in precious metals for retirement accounts. Fred has helped thousands of clients safe-guard their investments with gold and other precious metals. He has been with Gold Alliance for over three years as a leading Sr. Portfolio Manager.