Sprinting on the Treadmill

Macro Perspectives: Tue 15 Mar 22

After two years of massive government and central bank intervention - creating almost $6.5 trillion of new money - the Fed will begin reversing these policies tomorrow.

Despite months of telegraphing this move, we opened this week with the 10-year yield at just 2% (slightly higher as I write this). That's also despite a new catalyst that may spike an already high inflation rate (i.e. the recent spike in oil prices).

So, why is the interest rate market not pricing in an impending Fed inflation battle?

Because they are betting on the "demand destruction" thesis - higher prices will solve higher prices. In the case of gas prices, we know $4 gas has, historically, proven to be a psychological level that changes consumer behaviours, we saw it in 2008, 2011 and 2012.

But the economy is in a very different position this time.

Ten years ago, consumer and corporate balance sheets were wrecked. The economy was barely growing, even with maximum support from the Fed (QE and zero rates), and the job market was abysmal with unemployment running around 8%, with about a fifth of the employed being "underemployed." With these conditions, add in $4 gas and you will get demand destruction.

Fast forward to today: asset prices have reset higher (following the onslaught of new money creation). But, very importantly, the job market is tight and wages are adjusting for the rise in asset prices, and consumer and balance sheets are strong.

The demand destruction scenario is far less likely given this backdrop.

It's when the Fed ratchets rates high enough to reverse hot inflation, then the demand destruction will come. Until then, the sprint on the treadmill will become increasingly faster to maintain quality of life, in the face of high prices.