Unless you’re a contrarian, you’ve probably heard the forecast that the U.S. is headed into a recession sometime later this year. Normally this is signaled by a contraction in the GDP for two consecutive quarters, as well as an increase in unemployment claims and layoffs.
The thing is, this recession may be in part fueled by intentional decisions by the Fed to arrest the high inflation rate in order to get to the target of two percent inflation. While the Fed mandate to achieve price stability by lowering inflation is laudable since it helps the poor, their solution also has side effects, particularly the interest rate hikes. The quantitative tightening is more the availability of liquidity for the markets, since a high M2 excess money supply correlates positively to inflation.
It is one thing for natural events to conspire to wreck an economy. It is another to intentionally slow one down. The problem is whether it is high inflation or recession, people will get hurt. Countries like Argentina are struggling with hyperinflation. Imagine not knowing how much a meal will cost because the price has changed an hour after you ordered it. That’s why Fed Chairman Jerome Powell keeps harping on price stability.
On the other hand, in a recession or slowdown where the economy contracts, people lose their jobs. Lots of business deals and activities get halted. People don’t want to take out bank loans, the lifeblood of any economy, because interest rates are high. People don’t want to buy houses or property unless they have cash upfront, which very few people have. Most people need to take out mortgages, and many will prefer not to at this time because of the higher rates. In turn, property sellers prefer not to sell because, with few buyers, they won’t get the price they want. It’s all intertwined.
The problem here is that the Fed is free to define the two percent inflation target. They are free to define how to compute what inflation is. Does it include housing and energy? What is the CPI based on? Is it even appropriate? Are we just adjusting our economy based on a group of academics testing their theories but affecting people’s lives?
Sure inflation is important. If a janitor or bus driver can no longer afford foodstuffs like milk, eggs, and other staples, and can no longer pay rent because it keeps increasing at a fast clip, then definitely that is an issue.
However, is this the best we can do? Do we need to destroy the economy in order to save it? What if the two percent core inflation target can actually be three percent without causing harm? Or four percent?
There are also different economic conditions in the cities, the small towns, and other places. Some may have widescale unemployment, some may have runaway inflation, others might have an oversupply of jobs, some have a shortage of houses and so forth. But the Fed can only respond on average, so each rate hike will affect each place differently.
Plus, when the Fed economists get the data, there is already a lag or delay. In addition, they are just sampling the population, so there is a bit of an error there. However, this can be managed by proper statistical sampling.
Nevertheless, there is a delay in gathering the economic data and reacting to it with tightening, interest rate hikes, pauses or decreases, or quantitative easing. Also, it’s not like you are fine-tuning the response. There is a chance that the Fed can slam the economy into a hard landing straight into a recession because they are working with errors and delays in the data. They’re also not adjusting rates and liquidity just to certain areas. They’re doing it nationally for everyone.
As investors, we often prepare for macroeconomic events, or in the case of stocks, the performance of particular companies and their management teams. Unfortunately, in this case, the perturbations are coming from the Fed. So as investors, what can you do? Consider all your options. For more flexibility, consider short-term options. Review your stocks for those with revenues less susceptible to recessions. Review options for commodities. No one can perfectly predict the future, but having hedges for various eventualities may protect you in many cases.
Having a centralized planning organization that oversees the economy with delayed data is reminiscent, to me, of Soviet Russia and other communist countries. There should be a better way to adjust for economic conditions than what we are doing now.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.