2021_12_06 — THEME: The Fed, Inflation, and Conundrums

December 6, 2021

Michael’s CIO (Check It Out) Report on the week just past — events, sarcasm, and global macro reflections

Credit: Pipilotti Rist exhibit at Geffen MOCA; photo and graphics by Michael Ashley

THEME: The Fed, inflation, and conundrums

• FedUp: Amazon will pass FedEx and UPS to become the nation’s largest delivery service by early 2022 — fascinating how quickly they built this
• Twttr Out: Jack Dorsey will remain CEO of Square but will resign as Twitter’s CEO — could be a positive. BTW: The world’s first tweet, “just setting up my twttr” was sold in March as an NFT (a digital image with a digital fingerprint) for $2.9MM
• Growth: U.S. economic momentum seems to be positive with increased hiring, stronger wages, goods consumption remaining strong, and service consumption improving
• Fed Club: The first and second rule of Fed Club for the last two years was do not talk about, do not even think about inflation — Federal Reserve Chair Powell has now broken that rule by saying that inflation is elevated and likely to persist
• StayFlation: Powell suggested the central bank will quicken its reduction of economic stimulus by buying even less bonds every month (accelerating the taper) and has accepted that higher inflation is here to stay. We’ve mentioned higher inflation, StutterFlation, and StayFlation for a while; glad the Fed is finally on board😏 — and now that inflation is recognized, investors expect the Fed to do something about it
• Hints: Over the last decade, the Fed has developed a reputation for often signposting its moves — with varying degrees of success — well in advance so as not to surprise investors; thus talking about inflation hints at an increase in short-term Treasury rates in mid-2022
• Conundrum 1: If after more than a decade of low inflation we’ve finally seen greater than 2% inflation because of 1) Supply chain disruptions, 2) Higher import tariffs, and 3) A higher Chinese renminbi (which makes imports more expensive), will higher Fed rates cure the problem? I have serious doubts🤨
• Conundrum 2: Conventional wisdom says that low interest rates cause inflation, but is that always the case?🧐 Low borrowing rates may promote inflationary demand in developing economies where families are likely to buy their first refrigerator, washer, dryer, and dishwasher; but in an already developed economy with plentiful credit, that link seems weaker. In a developed economy like the U.S., low interest rates promote corporate borrowing for capital expenditures on production and technology to improve efficiency and increase supply, thus suppressing inflation. Therefore, in a developed economy with good credit facilities, low rates may have a deflationary effect because they incentivize more efficient production [see Japan]
• Conundrum 3: Thus, higher Fed interest rates may suppress economic growth, but not directly suppress inflation
• Home Loans: The Federal Housing Finance Agency raised the 2022 baseline limit on conforming mortgage loans +18% to $647,200, an increase of +$98,950 from $548,250 in 2021🏡 The new loan ceiling for high cost areas (L.A. and Orange County, Bay Area, NY and DC metros, a couple counties in Utah, and Teton County in Idaho and Wyoming) leapt to $970,800 — higher conforming limits should make homes more affordable, but ironically also support higher prices
• ShellShock: Royal Dutch Shell announced it will not increase spend on oil production even as fossil fuel prices rise, instead continuing its transition to renewables— 🛢This flips commodity economics on its head because in the past, rising prices led to increased production
• Bond Speak: Investment-grade corporate bonds reached their widest spreads (largest difference in yield versus Treasuries) in a year as the Omicron Covid variant hit headlines — in other words, corporate bonds look cheap relative to U.S. Treasuries
• Brazil underachieved with two slightly negative growth quarters in a row — feels like a recession in Latin America’s largest economy😳
• Rohan: Google’s first Pixel smartwatch may launch in 2022 and provide health and fitness data😤⌚
• Dainese: Investcorp may sell Italian motorcycle protective clothing brand Dainese for nearly 750MM euros 🏍
• Geoffrey: Toys “R” Us🦒will relaunch again with a flagship store at the American Dream megamall in New Jersey and then will open mini-shops in Macy’s department stores beginning in 2022

Best wishes for the week ahead😃,
Michael
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Michael Ashley Schulman, CFA
Partner / Chief Investment Officer

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