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Rational Exuberance - The Equitile Blog

18th March 2021

Posted by: George Cooper

Making a Virtue Out of a Necessity

 

Yesterday’s FOMC statement is important (March 17th 2021).

There are three points worthy of note:

1: “the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time”

This is a commitment to the ‘make up strategy’ whereby the Fed seeks to achieve higher future inflation to make up for previously having failed to achieve its desired 2% inflation target. From the FOMC’s perspective, this narrative provides the flexibility keep interest rates extremely low even if it becomes manifestly clear it is failing to maintain inflation at or below its 2% target. This is, as explained by the following passage, now the FOMC’s goal:  

2: The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.

The FOMC’s goal is first to achieve a negative real interest rate of at least 2% and then to maintain that negative interest rate for ‘some time’. In other words, the FOMC would like to see the spending power of money, saved in the government bond markets, falling by at least 2% per year for the foreseeable future. In order to achieve this the committee is making an open-ended and asymmetric commitment to balance sheet expansion, arguably a euphemism for debt monetization:

3: Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee's maximum employment and price stability goals.

In our view, FOMC is being both honest and pragmatic, effectively admitting the cost of the economic lockdown policies of 2020 and 2021 can only be funded through the printing press. As a result, we believe we are already in the early stages of an uptrend in inflation which will likely last several decades.

We expect the inflation trend to be maintained and accelerated through monetary and fiscal policy coordination; governments will continue spending far beyond their means and central banks will continue ‘footing the bill’ with monetization and negative real interest rates. If so, the global government bond markets will cease to be a viable long-term savings vehicle for the private sector.    

 

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