The Fed’s epic battle with inflation

Stocks ended the month on a sour note, falling for a 4^th straight session as traders come to grips with an indifferent Fed. Despite a valiant effort, stocks just could not reach escape velocity in August, giving back some hard-won gains from July.

Hellbent. It has been almost a week since Jerome Powell gave his speech at Jackson Hole. He didn’t really say anything that we didn’t already know, but there was something about his tone that just didn’t sit well in the craws of stock traders. Still bewildered on Monday, stocks sold off. By Tuesday, traders attempted to rationalize that queasy feeling with something akin to Scrooge’s “undigested beef”. Or maybe it was an “underdone potato,” hoped traders by yesterday. Early rally attempts were quashed for 2 straight sessions as that gastric discomfort would simply not abate.

Most of my readers will recall Paul Volcker, the Fed Chair who presided over the Central Bank during Jimmy Carter’s and part of Ronald Regan’s presidencies. Go on, you remember those years, and one thing that probably sticks in your mind from those years is…high inflation. Let’s get more specific. He served as the Fed Chair from 1979 through 1988. When he was sworn in, inflation was around +10%...and growing. Just 5 years earlier, inflation had topped off above 12%. Inflation was atop everyone’s list of pain those days. It was an economic and political disaster. No one wants to be in charge of a rudderless ship, and Volcker was brought in for one principal reason: to fight inflation and send it back to the underworld from which it was borne. You may not be surprised how he set about vanquishing the beast. He raised interest rates with deep resolve! Fed Funds were pumped to 17% as inflation reached almost +15%, and wouldn’t you know it, a recession ensued. The unemployment rate rose over 7%. Mortgage rates would reach some +16% during the recession, which would last 2 quarters. BUT Volcker would not be satisfied until there was no trace left of the wretched archfiend, inflation. By late 1981 inflation was still around +10% and Fed Funds rocketed as high as 19% as the US entered the second recession in a 2-year period. This one would last through 1983 not before the unemployment rate got to 10.7%. But it was not all for naught…inflation, the despised creature, had been defeated and was back down to a more tolerable +3.8%. Paul surely received presidential accolades and was replaced by a more outspoken Alan Greenspan in 1987, he faded into obscurity and reemerged as an economic advisor to President Obama in the wake of The Great Recession to aid in the economic recovery. He died, unceremoniously in late 2019. The end. Today, Volcker is remembered as the inflation slayer, mostly by economics students…UNTIL LAST FRIDAY.

In Powell’s press conferences, he is often asked by reporters about Paul Volcker. The implication of the question is largely focused on whether the current chair would be willing to hike interest rates to eye-watering, painful, 1980s-style heights in order to stop this current spate of inflation. Powell, a masterful avoider of tough-to-avoid questions, was almost always able to pay respectful homage to his predecessor while always stopping short of committing to take such a route. In last Friday’s speech, some of Powell’s wording and body language appeared as if he were channeling the long-lost inflation fighting energy of none other than Paul Volcker. This was a wakeup call for stocks and the reason for this most recent rout in shares. Objective number 2, get capital markets back to reality, is achieved. Objective number 1: inflation, is still incomplete. Objective number 3: loosen the labor market, is still incomplete, but we will learn more on Friday. Also, we are getting more and more reports of companies announcing job cuts, which may find its way into employment numbers in the months ahead. Secret objective number 4, cause a Volcker expanded-contraction-style recession…almost complete. This is no “blot of mustard” or “crumb of cheese,” it is, indeed the Ghost of Inflation Past.

YESTERDAY’S MARKETS

Stocks struggled to hold onto any gains losing ground in the final day of August as the aggressive Fed continued to worry traders. The S&P500 fell by -0.79%, the Dow Jones Industrial Average traded lower by -0.88%, the Nasdaq Composite Index slipped by -0.56%, and the Russell 2000 Index gave up -0.62%. Bonds fell and 10-Year Treasury Note yields gained +9 basis points to 3.19%, breaking through key resistance levels. Cryptos gained +1.17% and Bitcoin climbed by +1.10%.

NXT UP

• Initial Jobless Claims (August 27) is expected to come in at 248k, slightly higher than last week’s 243k.
• Construction Spending (July) is predicted to have fallen by -0.2% after falling by -1.1% in the month prior.
• ISM Manufacturing (August) may have receded to 51.9 from 52.8