Will Growth Outpace Inflation?

Macro Perspectives

We head into August with a bear market for stocks behind us.

That bear market was pricing in a Fed tightening campaign, which included the Fed's threat of reversing QE (i.e. extracting liquidity from the system).

The broad market drawdown delivered the justification the democrat-led Congress needed to push through more government spending, in the name of "inflation relief." As we discussed last week, and was admitted by the President, this is their coveted Build Back Better plan, now on path to be funded.

In short, the plan that created inflation (through policy-driven supply destruction of commodities, including labour), is now going to be super-charged under the label of the “Inflation Reduction Act”.

What should we expect? Inflation. And we should expect the Fed to do nothing to counter it.

• They've intentionally remained well behind the curve on inflation - the last year-over-year inflation reading was 9.1%. Yet Jerome Powell just told us that an effective Fed Funds rate of 2.3% is neutral.

• They told us they would be shrinking the balance sheet by $95 billion at this point (two months into their quantitative tightening plan) - they've done just a third of that plan. 

So, we should expect inflation to persist, just without the headwinds of idle threats to contain it, from the Fed. And with nearly a trillion dollars of new government spending coming down the line, on economically transformative spending, the economy will be hot. The question is, will this tailwind of spending be enough for growth to outpace inflation (i.e. will it produce meaningful 'real' economic growth)?