FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
May 25, 2021

IN THIS ISSUE:

1. Inflation Outlook – The 800-Pound Gorilla in the Room

2. Fed Reveals Surprising Discussion at Latest Policy Meeting

3. Household Income Surged By Record 21% in March

Overview

There was the usual mish-mash of financial news last week, some good and some bad. Equity markets weakened early last week as analysts and investors struggled to balance the strengthening economic recovery against a broad-based surge in consumer and goods prices in April.  

Asset prices have been shaken by the prospect of inflation derailing the recovery from the pandemic, and potentially nudging the Federal Reserve to reverse its crisis-era zero interest rate policy sooner than expected.

On Thursday, the Dow, S&P and Nasdaq managed to snap a 3-day losing streak on news that workers filing for new unemployment benefits fell to a new COVID-19 era low, their lowest in over a year. 

Still, the 800-pound gorilla in the room remains the latest much higher than expected inflation reading for April which saw the Consumer Price Index jump to an annual rate of 4.2%, the highest level in 12 years. This remains the #1 topic of discussion among market participants.

The question, of course, is whether inflation will remain at these elevated levels, or whether this is just a “transitory” move before moving back to more normal levels, as the Fed would have us believe. Time will tell.

Along this line, the Fed released the minutes from its April 27-28 policy meeting, and therein was a bit of a surprise. According to the minutes, there was more than passing discussion regarding whether the Fed should dial back its monthly purchases of bonds and other securities should the economy continue to strengthen just ahead. This news came as a surprise to the markets as I will discuss below.

Inflation Outlook – The 800-Pound Gorilla in the Room

As I discussed at length last week, the April CPI jump to an annual rate of 4.2% was indeed a negative development. However, the fact that CPI went up last month was not a surprise. The only surprise was simply that it rose more than expected.

We knew the April inflation rate was going to be higher due to the fact that the very low April 2020 data point was going to roll off the 12-month calendar window. The pre-report consensus among economists surveyed by Bloomberg called for an increase to 3.6% (annual rate) for April. While the 4.2% print was well above the pre-report consensus, it wasn’t that much higher.

The question is, why are we still talking about it, especially with the Fed assuring us it will only be “transitory” (temporary)? I have several thoughts on this question. First, as always, we have a large contingent of so-called “inflation hawks” who always warn of substantially higher prices. Never mind that many of these same people have been consistently dead wrong for the last 20-30, even 40, years. The latest CPI report on April 12 was music to their ears!

Another thought I have is this: Most Americans have never experienced really high inflation. As you can see in the chart above, the last time we had double-digit inflation was back in 1979 and the early 1980s. Unless you are in your 60s or older, you probably have little or no recollection of what that period was like.

In 1979, the CPI hit 11.3%. In 1980, it hit 13.5%. In 1981, the Fed Funds rate soared to 20%. In 1982, the prime rate rocketed to 21.5%. Again, unless you are in your 60s or older, you probably have no memories of this. For most Americans, they don’t know who to believe.

My point is, there is a lot of confusion over inflation among those under 60. The surprise report for April putting year-over-year inflation at 4.2%, the highest level in 12 years, has a LOT of people wondering where it goes from here.

Fed Reveals Surprising Discussion at Latest Policy Meeting

Last Wednesday, the Fed released the minutes from its latest Fed Open Market Committee (FOMC) policy meeting held on April 27-28. To put this latest discussion in perspective, the Fed has been maintaining for much of the last year that it has no plans to change monetary policy anytime soon. Likewise, it plans to keep the Fed Funds rate near-zero indefinitely.

As you are probably aware, the Fed buys billions in US Treasury bonds and other securities each month to pump liquidity into the markets and keep interest rates low, in a process known as “Quantitative Easing” (QE). For the last year, the Fed has been buying $120 billion a month in these securities, and there had been no indication this aggressive buying will end anytime soon.

I believe it is important to point out the fact that the Fed’s balance sheet has exploded since early 2020, as shown above. The Fed’s balance sheet of Treasury bonds and mortgage-backed securities has now exceeded $7 trillion and is growing rapidly.

With the Fed’s QE bond buying expected to continue indefinitely, concerns are increasing on the limits to the central bank’s balance sheet. Up to now, the Fed has suggested there is no limit to how many bonds it can buy, but this controversial position may be changing, as I will discuss below.

The April FOMC meeting minutes released last week came as a surprise because they revealed the FOMC members had substantive discussions about changing one important policy position just ahead – if the economy continues its strong rebound.

Those minutes revealed that the FOMC members discussed the possibility of reducing the level of monthly QE bond purchases just ahead – if the economic recovery continues to strengthen. This is good news in my opinion. The minutes read:

“A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”

While the latest Fed minutes did not indicate there was any discussion about raising interest rates anytime soon, the fact that the FOMC did discuss reducing its monthly securities purchases – perhaps as early as late this summer -- certainly got ALL Fed-watchers’ attention!

The FOMC meets next on June 15-16 and a great deal of attention will be focused on what is discussed at that meeting, especially any further talk of reducing bond purchases later this year.

You may recall a similar situation in 2013 when then-Chairman Ben Bernanke and others on the FOMC suggested the idea of cutting back on QE bond purchases, and the stock markets plunged for several days. The idea of cutting bond purchases back then was nicknamed the “Taper Tantrum,” and the idea was quickly scuttled.

Markets don’t like Fed surprises. I’ll stay on top of this development and keep you posted.

Household Income Surged By Record 21% in March

Household income rose at a record pace of 21.1% in March as federal stimulus checks helped fuel an economic revival which is poised to continue enduring with an easing pandemic. The 21.1% March surge in income was the largest monthly increase for government records tracing back to 1959, largely reflecting $1,400 stimulus checks included in President Biden’s fiscal relief package signed into law in March.

Spending was also up sharply, increasing 4.2% in March, the Commerce Department reported. This was the steepest month-over-month increase since last summer. Consumers shelled out more money on goods, particularly big-ticket items such as autos and furniture, compared with services in March. But economists expect consumers to spend more on services just ahead.

Americans have plenty of cash to spend. The personal-saving rate surged to 27.6% in March, the second highest rate on record, eclipsed only by last April when a first round of government aid was distributed early in the pandemic.

Personal savings amounted to about $6 trillion in March, up by nearly $5 trillion from February 2020, the month before the pandemic shut down large parts of the economy. Wealthier households, which suffered fewer job losses during the pandemic, have run up the bulk of savings during the pandemic.

Consumer spending is the biggest factor behind economic growth in the US, accounting for almost 70% of GDP. Spending has held up solidly throughout the pandemic, as consumers ramped up purchases of big-ticket goods, such as cars, home appliances, furniture, etc.

Although this robust economic growth is welcomed, it does come with a caveat: the potential for higher inflation in the months ahead. How much inflation rises remains to be seen, as discussed above. A big factor is how much small and medium-sized businesses will have to raise wages to fill empty positions.

It should be a very interesting rest of the year and in 2022. Keep your seatbelts buckled!  

Very best regards,

Gary D. Halbert

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