John De Goey is a senior investment adviser and portfolio manager with Wellington-Altus Private Wealth (WAPW).
Central bankers around the Western world acted swiftly and purposefully when confronted with the major economic slowdown caused by a global virus in early 2020. That is to their credit. Largely due to their active involvement in keeping the economy moving, the market downturn lasted only about five weeks and stability was restored, allowing growth to materialize where few would have expected it.
If you need quick, purposeful action to get your economy back on track, central bankers have shown they can and will have your back. How purposeful? In the United States, the Federal Reserve cut interest rates by 150 basis points (a basis point is 1/100 of a percentage point) between March 3 and 15, 2020. A 1.5-percentage-point drop in less than two weeks!
However, in time it became apparent that supply-related constraints might cause inflation to spike unexpectedly. In truth, concern about inflation became well-known by Q2, 2021 – over a year ago.
What did intrepid central bankers do to combat the inflation so many analysts saw coming? For starters, the central bankers spent the rest of 2021 saying it was no concern to them, even while they saw some inflation on the horizon. It would be only transitory. It would pass as quickly and harmlessly as a single thundercloud on a sunny day.
Central bankers offered calming assurances, but did nothing to change their actions. They insisted patience was required and the economies of their countries would be allowed to run hot in order to prolong the growth their easy-money policies of 2020 had initiated. To hear them tell it, what looked like a looming storm ahead was merely a couple of rogue readings that would quickly fade from memory. Indeed, rates would stay at all-time lows for the next year, at least.
By 2022, the tables had turned, and the central bankers’ story changed. Only a couple months into the year, they admitted some rate hikes might soon be needed after all. As we moved into spring, the situation worsened. Signals became actions and the necessary hikes finally started to happen in earnest.
Now that we have hit the midyear point, inflation in Canada is at a 30-year high, and a 40-year high in the U.S. It goes without saying, but the raison d’être for central banks is to provide price stability by giving consumers confidence their purchasing power will not be eroded. Thus, the situation should not have come to this.
On June 15, the U.S. central bank lifted interest rates by 75 basis points, the third hike this year and the largest since 1994. That brought the total of all rate hikes in 2022 to 1.75 percentage points. The move was aimed at countering inflation clearly on the verge of getting out of control.
The contrast between the Fed raising and lowering rates is stark. In 2020, when cuts were desperately needed, the central bank lowered rates by 1.5 percentage points in just 12 days. In 2022, when hikes were desperately needed, the central bank raised rates by 1.75 percentage points – but over six months. What does this mean? That the urgency to raise or lower rates is anything but equivalent.
In the late 1970s and early 1980s, Paul Volcker, then chair of the Federal Reserve, raised rates to punitive levels and crushed inflation before it could become systemic and ingrained in the public psyche. These days, central bankers talk tough, but with inflation about six percentage points above the bank rate, their credibility as protectors of price stability is in question.
The narrative from monetary policy mavens is that central bankers are trying to thread a needle by reining in inflation without crashing the economy. Fed chair Jerome Powell has been quoted as saying a “softish” landing for the economy is still possible.
Many observers, me included, no longer think that is the case. The time has come to choose. Will we squash inflation or tank the economy? By the way, there’s a very real possibility that if we don’t squash inflation, the economy will tank anyway. My vote is, and has always been, that central bankers should focus on squashing inflation.
Recently, Nomura Holdings Inc., a Japanese financial holding company, went on record to suggest the world is now hurtling toward a synchronized recession – with all major economies being hit by a downturn at more or less the same time later this year. A “softish” landing no longer seems attainable.
As the consensus emerges that we are in for difficult times, we might as well just rip off the Band-Aid and deal with inflation while we’re at it. Slowing inflation will involve slowing growth to the point of throwing the gearbox into reverse. The widely accepted definition of a recession is two consecutive quarters of “negative growth,” a euphemism used by economists that means economic contraction.
The U.S. economy contracted in Q1 and virtually all indicators suggest it contracted in the recently concluded Q2, too. In other words, we’re likely already in a recession and it just hasn’t been made official yet. Central bankers have no mandate to avoid recessions or to manage business cycles. Now is the time to tame inflation, no matter the cost.
The information contained herein has been provided for information purposes only and is not a recommendation or solicitation to buy or sell securities of any kind or to employ any particular strategy. Please contact your financial adviser for advice with respect to your personal financial situation and objectives. WAPW is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.
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