What the Fed should do

Some lovely, succinct points from Jason Furman, an economist at the PIIE, which we follow.

Firstly, what the Fed should do in 4 friendly points.

  1. More realistic inflation outlook.
  2. Clearer statements on dual mandate.
  3. Taper asset purchases more aggressively.
  4. Set expectation for rising rates in first half of 2022 unless inflation/employment growth are lower than expected

We agree!

Secondly, since we are spending so much time discussing supply side effects, what precisely does the current supply side shock look like?

Here’s one where your supply curve shifts, e.g. an electricity crisis shuts down factories in China, and so they can’t make electronics. Or think high natural gas prices that mean you can’t make fertiliser, or aluminium. P (price) rises, Q (quantity) falls.

And here’s the other, where the supply curve just can’t make stuff fast enough, in response to a shift in demand. This is mostly what’s happened, as goods demand surged (services fell), and production rose, but not fast enough. P (price) rises, Q (quantity) also rises.

How do we know it is the second one?

Because GDP is up, and we can literally see the backlogged ships and containers that are stuck at port, full of newly produced things…


…and we also know that port throughput (volume) numbers are up.

Why does any of that matter? Who cares? Well, because in the first one, there’s not a huge amount monetary policy can or should do. You definitely shouldn’t tighten policy.

However in the second one, if monetary policy is spurring demand, which cannot be met outside of price hikes, then monetary policy should react.

We use economic theory to tell us that the Fed can and should look to moderate an overheated economy through rate hikes.

For that reason, we are underweight fixed income (doesn’t mean having none, as the negative correlation to equity market risk is very handy) and we are underweight secular growth stocks, and long duration stocks (which is a similar, but wider, list of stocks).

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