{"id":674,"date":"2023-09-15T09:41:51","date_gmt":"2023-09-15T14:41:51","guid":{"rendered":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/?p=674"},"modified":"2023-09-15T09:41:51","modified_gmt":"2023-09-15T14:41:51","slug":"september-market-insights-the-feds-high-wire-act-dr-jim-thorne","status":"publish","type":"post","link":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/2023\/09\/15\/september-market-insights-the-feds-high-wire-act-dr-jim-thorne\/","title":{"rendered":"September Market Insights: The Fed\u2019s High-Wire Act &#8211; Dr. Jim Thorne"},"content":{"rendered":"<div class=\"elementor-element elementor-element-3e906c93 elementor-widget elementor-widget-theme-post-title elementor-page-title elementor-widget-heading\" data-id=\"3e906c93\" data-element_type=\"widget\" data-widget_type=\"theme-post-title.default\">\n<div class=\"elementor-widget-container\">\n<h1 class=\"elementor-heading-title elementor-size-default\"><\/h1>\n<\/div>\n<\/div>\n<div class=\"elementor-element elementor-element-5263f5a3 elementor-widget elementor-widget-post-info\" data-id=\"5263f5a3\" data-element_type=\"widget\" data-widget_type=\"post-info.default\">\n<div class=\"elementor-widget-container\">\n<ul class=\"elementor-inline-items elementor-icon-list-items elementor-post-info\">\n<li class=\"elementor-icon-list-item elementor-repeater-item-c02e8ee elementor-inline-item\"><span class=\"elementor-icon-list-text elementor-post-info__item elementor-post-info__item--type-date\">September 13, 2023<\/span><\/li>\n<\/ul>\n<\/div>\n<\/div>\n<div class=\"elementor-element elementor-element-4ff4ea7f elementor-widget elementor-widget-theme-post-content\" data-id=\"4ff4ea7f\" data-element_type=\"widget\" data-widget_type=\"theme-post-content.default\">\n<div class=\"elementor-widget-container\">\n<h2 class=\"wp-block-heading\">Discretion is the Better Part of Valour<\/h2>\n<p><em>\u201cWe are navigating by the stars under cloudy skies.\u201d \u2013 Chairman Jerome H. Powell, August 25, 2023<\/em><\/p>\n<p><a href=\"https:\/\/wellington-altus.ca\/wp-content\/uploads\/2023\/09\/September-Market-Insights-by-Dr.-James-Thorne-The-Feds-High-Wire-Act.pdf\" target=\"_blank\" rel=\"noreferrer noopener\">Download this PDF here.<\/a><\/p>\n<p>The adage, \u201cDiscretion is the better part of valour,\u201d has never been more pertinent as the U.S. Federal Reserve cautiously navigates between the perils of inflation and deflation. In the world of economic policy, the Federal Reserve finds itself delicately engaged in a balancing act akin to a tightrope walker traversing a starlit sky obscured by clouds. The elusive concept of the \u201cneutral interest rate\u201d remains shrouded in uncertainty, and one could plausibly argue that rate hikes possess an inflationary nature. With continued reliance on outdated economic theories and models, the present quandary should come as no surprise.<\/p>\n<p>The global economy has weathered two external shocks, resulting in an unprecedented inflationary upheaval. In response, central bankers tightened financial conditions by raising short-term interest rates to levels exceeding 5%. However, before the full ramifications of these rate hikes could materialize, inflation experienced a significant decline. By some metrics, inflation now resides close to the Federal Reserve\u2019s targeted 2% threshold.<\/p>\n<p>This has ignited a spirited debate among experts, with some contending that the rate hikes were misguided while others advocate for further increases. Personally, I maintain the belief that hikes surpassing 2.5% were unnecessary, and the possible rate hikes in 2023 have the potential to culminate in a substantial policy misstep, evoking memories of the debt and deflationary concerns that plagued the aftermaths of the First and Second World Wars.<\/p>\n<figure class=\"wp-block-image size-large is-resized\"><a href=\"https:\/\/wellington-altus.ca\/wp-content\/uploads\/2023\/09\/CPI-LESS-SHELTER.png\"><img fetchpriority=\"high\" decoding=\"async\" class=\"wp-image-8011\" src=\"https:\/\/wellington-altus.ca\/wp-content\/uploads\/2023\/09\/CPI-LESS-SHELTER-1024x730.png\" alt=\"\" width=\"840\" height=\"598\" data-pagespeed-url-hash=\"3482983969\" \/><\/a><\/figure>\n<p>The recent Jackson Hole Economic Symposium perfectly illustrates this quandary as policymakers grapple with the timing of their actions. Acting too swiftly risks pushing the economy into deflation and a recession. On the other hand, delaying action may allow inflation to spiral out of control.<\/p>\n<p>The highly anticipated speeches by U.S. Federal Reserve Chair Jerome Powell and European Central Bank (ECB) President Christine Lagarde marked a nuanced yet significant shift from a sole focus on inflation to an acknowledgment of the deflationary and recessionary risks associated with overtightening. This nuanced perspective reflects the Federal Reserve\u2019s delicate balancing act as it seeks to navigate the economic landscape with precision and foresight.<\/p>\n<p>Moreover, Austan Goolsbee, President of the Federal Reserve Bank of Chicago, foresees a \u201cGolden Path\u201d to deflate inflation without sparking a recession. We are now witnessing the end of the most aggressive tightening cycle in modern history. However, if history serves as a guide, the consensus that \u201cThis time is different\u201d may be misguided. In a world rife with uncertainty, investors require clarity, flexibility, and humility. They must cultivate a forward-looking vision, a task that is becoming ever more challenging in an environment marked by frequent exogenous shocks, a rise of populism, the emergence of new technologies, and an increasingly interconnected world. Yet, if we look at history, the risk of a deflationary episode of secular stagnation, like the aftermaths of the First and Second World Wars, should not be overlooked by policymakers and investors. As the old saying goes, \u201cThis time, it\u2019s not different.\u201d<\/p>\n<p>Therefore, it is crucial to consider historical patterns and lessons as we navigate these uncertain times. Policymakers at Jackson Hole (like Powell and Lagarde) gave many clues, yet, as usual, most were ignored. The consensus is their speeches were hawkish. I disagree. Both speeches were balanced and hinted that they understand the risks are now symmetric, balanced between inflation and deflation. We provide some much-needed context.<\/p>\n<p><strong>An End to the Rate-Hiking Cycle<\/strong><\/p>\n<p>At the recent Jackson Hole Economic Symposium, Federal Reserve Chair Jerome Powell acknowledged the strides made in taming inflation but cautioned that we are not out of the woods yet. He underscored the need for vigilance until inflation is tamed to the 2% target. Simultaneously, he warned against the perils of overzealous monetary policy, which could thrust us into a recession. Powell\u2019s nuanced speech hinted at a higher threshold for continued rate hikes, suggesting that the risks are now evenly poised between inflation and deflation.<\/p>\n<p>The market\u2019s obsession with the inflation-ridden 1970s blinds it to the potential for a debt\/deflation crisis, reminiscent of Irving Fisher\u2019s analysis of the Great Depression. Overtightening in a global economy with extreme debt levels creates a post-First and Second World War deflation-recession scenario.<\/p>\n<p>Powell\u2019s speech hinted at an upcoming pause in rate hikes, suggesting that the Federal Reserve\u2019s objectives are increasingly within grasp. This cautious approach \u2013 a recognition that the policy rate is in restrictive territory \u2013 coupled with a pause to evaluate, signals a data-dependent stance, with the Fed keeping a close eye on economic indicators before making further policy decisions. It\u2019s a very good sign.<\/p>\n<p>The speech did not slam the door shut on rate hikes, but it did lay the groundwork for a potential \u201cmission accomplished\u201d speech in November. This announcement will offer more explicit guidance on the Federal Reserve\u2019s future policy actions and the trajectory of interest rates. The glide path of inflation back to its 2% target is unknown, however, with the foundational forces of deflation strengthening, we cannot rule out a deflationary shock in 2024. Japan\u2019s lessons from the 1990s are being ignored. How quickly we forget the concern about the inability to achieve the 2% inflation target in the pre-COVID-19 world. True, many proclaim that we are in a new inflationary era, but history does not support such bravado-induced proclamations by many on Wall Street.<\/p>\n<p>Powell\u2019s speech came at a time of escalating global market uncertainties, including trade tensions, geopolitical risks, and emerging market vulnerabilities. Some interpret the Federal Reserve\u2019s cautious stance as a response to this challenging backdrop, given its efforts to maintain stability and foster economic growth.<\/p>\n<p>Over the past two years, the Federal Reserve\u2019s communication strategy has been hawkish, aiming to shape inflation expectations. However, Powell\u2019s speech hints at a potential end to the rate-hiking cycle. Despite this shift, Wall Street and market participants often interpret the Federal Reserve\u2019s messaging as biased towards continued hawkishness. This tendency stems from their desire for clarity amidst uncertainty.<\/p>\n<p>The challenge for Powell lies in effectively communicating the central bank\u2019s intentions to Wall Street and the broader market. Even if the last rate hike has already happened, Powell must convey that the Federal Reserve\u2019s stance is evolving towards a more accommodative position. Without explicit communication, the assumption of continued hawkishness may persist. The Federal Reserve is on the brink of pulling off a soft landing, and it\u2019s high time the market took notice.<\/p>\n<p><strong>Christine Lagarde: \u201cLife Can Only Be Understood Backwards, but it Must Be Lived Forwards\u201d<\/strong><\/p>\n<p>To encapsulate policymakers\u2019 conundrum, ECB President Christine Lagarde\u2019s speech at Jackson Hole invoked philosopher S\u00f8ren Kierkegaard\u2019s famous quote, \u201cLife can only be understood backwards, but it must be lived forwards.\u201d They must anticipate the future and act accordingly, even though the true impact of their decisions will only be understood in hindsight.<\/p>\n<p>Lagarde identified three significant shifts in the current environment: 1) the escalating frequency and severity of global energy supply shocks, 2) a deepening geopolitical divide and fragmenting global economy, and 3) the rise of new technologies and their impact on the nature of work. These shifts could transform the nature of the shocks we face and their economic impact. Policymaking in this context demands clarity about policy goals and trade-offs, flexibility to adapt to new information and changing circumstances, and humility to recognize the limits of our knowledge and the potential for unintended consequences. Lagarde\u2019s speech did not receive the attention it deserved and may have contained clues indicating policymakers are about to shift focus and take a more holistic, forward approach.<\/p>\n<p><strong>Lurking in the Shadows are Significant Risks that Remain Unaddressed<\/strong><\/p>\n<p>China\u2019s economic challenges, including rising debt levels and the risk of deflation, pose significant threats to global economic stability. The end of China\u2019s growth miracle has shocked investors and policymakers worldwide and could trigger a national deflationary spiral that would reverberate through global trade and financial markets. However, it is important to recognize that China has entered a new era that is as transformative as its accession to the World Trade Organization decades ago.<\/p>\n<p>Henry Kissinger\u2019s book \u201cOn China\u201d cautions against evaluating China\u2019s strategic policies through a Western lens. Chinese President Xi Jinping has philosophical objections to Western-style, consumption-driven growth, viewing it as wasteful and counterproductive to his goal of transforming China into a leading industrial and technological power. Xi advocates for fiscal discipline, making stimulus or welfare policies similar to those in the U.S. and Europe less likely. This new era presents both challenges and opportunities for the global economy, and it is important that investors and policymakers carefully navigate this evolving landscape. Notably, Powell did not mention this topic as a risk in his Jackson Hole speech, raising the question of why the Federal Reserve is not more concerned about the potential impact of China\u2019s economic challenges on the global economy. The ongoing debt crisis is not isolated to China. Several regions, including Canada, Europe and other parts of Asia, are wrestling with an overreliance on the property sector, vulnerable banks burdened by high levels of non-performing loans, and weak capital buffers. The potential domino effect of a banking crisis in any of these regions could exacerbate global financial instability.<\/p>\n<p>The commercial real estate market also poses a potential risk. The prolonged low-interest-rate environment has sparked a frenzy in commercial real estate investments, leading to inflated property values and soaring debt levels. With financial conditions already restrictive, commercial real estate could face a harsh correction, potentially triggering a broader financial crisis.<\/p>\n<p>The common thread in all these unaddressed risks is the potential for deflation. Deflation, characterized by a sustained price decline, can wreak havoc on economic growth and financial stability, leading to reduced consumer spending, increased debt burdens, and downward pressure on wages and profits.<\/p>\n<p><strong>What Should Investors Do?<\/strong><\/p>\n<p>In conclusion, the economic landscape is a complex tapestry woven by policymakers like Christine Lagarde and Jerome Powell. Their insights into the future of interest rates are invaluable, but vigilance and proactive monitoring of these developments are paramount to mitigating potential risks and fortifying economic resilience. As for investors, strategically constructing a high-quality, balanced portfolio of stocks and bonds to navigate the potential headwinds of slow growth, disinflation, and declining rates is recommended. I favour the belly of the yield curve for bonds and companies poised for an investment led innovative era for stocks.<\/p>\n<p>However, we must not overlook the looming shadow of extreme debt levels and the possibility that central banks have over-tightened. The euphoria from the war-like fiscal policy, akin to a sugar high, is bound to dissipate. The impending shock from a potential debt\/deflation episode in China, a generational event, remains largely unaccounted for. Companies and economies that thrived on China\u2019s debt-fuelled urbanization boom are now on shaky ground.<\/p>\n<p>The famous proverb, \u201cDiscretion is the better part of valour,\u201d rings especially true in today\u2019s economic climate. Investors must navigate this high-wire act with precision, balancing the risks of inflation and deflation to safeguard the long-term health and stability of their portfolios.<\/p>\n<p>Contrary to the consensus, I posit that deflation is a significant risk. Current growth, largely fuelled by extreme debt, is more a fleeting sugar rush than a sustainable trajectory. As the high wears off, and as we witness a slowdown in China\u2019s growth reminiscent of Japan in the 1990s, the risk of a slow-growth deflationary scare looms large. This could dramatically alter the prevailing narrative of persistent inflation, leading to substantial rate cuts and a potential divergence from the so-called \u201cGolden Path\u201d of Mr. Goolsbee.<\/p>\n<p>The stakes are high, and the dance between inflation and deflation continues. As the dust settles, we propose that a slow-growth deflationary environment is a risk that investors must brace for. The economic future may be uncertain, but with vigilance, strategic planning, and a willingness to challenge consensus, we can navigate the storm and emerge stronger on the other side.<\/p>\n<\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>September 13, 2023 Discretion is the Better Part of Valour \u201cWe are navigating by the stars under cloudy skies.\u201d \u2013 Chairman Jerome H. Powell, August 25, 2023 Download this PDF here. The adage, \u201cDiscretion is the better part of valour,\u201d has never been more pertinent as the U.S. Federal Reserve cautiously navigates between the perils [&hellip;]<\/p>\n","protected":false},"author":83,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_oasis_is_in_workflow":0,"_oasis_original":0,"_oasis_task_priority":"","_exactmetrics_skip_tracking":false,"_exactmetrics_sitenote_active":false,"_exactmetrics_sitenote_note":"","_exactmetrics_sitenote_category":0,"footnotes":""},"categories":[1],"tags":[],"class_list":["post-674","post","type-post","status-publish","format-standard","hentry","category-uncategorized"],"_links":{"self":[{"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/posts\/674","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/users\/83"}],"replies":[{"embeddable":true,"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/comments?post=674"}],"version-history":[{"count":1,"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/posts\/674\/revisions"}],"predecessor-version":[{"id":675,"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/posts\/674\/revisions\/675"}],"wp:attachment":[{"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/media?parent=674"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/categories?post=674"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/advisor.wellington-altus.ca\/themorga-rossadvisoryteam\/wp-json\/wp\/v2\/tags?post=674"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}