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Everyone's a Winner!

The Federal Reserve Isn't Turning the Lights Down on This Party

The Latest from Jackson Hole Suggests the Fed Will Keep The Punch Out, Making Every Trade a Winner

Thomas Patch (1725-1782) - A Punch Party in Florence
"Toga! Toga! Toga!"

These are great times to be a trader. Prices only go one way. Every risk is compensated. Everyone's a winner. We don't envy Jerome Powell, Chair of the Federal Reserve Bank Board of Governors, his task. Balancing the twain objectives of ensuring full employment and price stability is becoming increasingly difficult. The Fed now faces the prospect of persistently higher price increases and widespread unemployment in the service sectors and among disparate racial groups in the US economy at a time when its primary tools for managing the economy are unavailable to it.

So it is that on Friday at Jackson Hole Powell reiterated his talking points of the past year: keep a watchful eye on developments in the labor market, allow current inflation to exceed long term targets, and dial back the Fed's monthly asset purchase program only once the US economy is out of the woods. This seems like the right policy program to us here at goodstead, as we continue to believe that inflation is transitory rather than persistent.

By Federalreserve - December 16, 2020 Virtual FOMC Press Conference, Public Domain,
Powell the Accommodating

Theoretically, inflation rates should track what is called the Output Gap, or the difference between potential output (how much an economy can produce) and actual output (how much an economy did produce). When actual production exceeds potential output for an extended period of time, then price pressures emerge and cause the general price level to increase. This is what we refer to as "running hot".

When looked at from a macroeconomic perspective, capacity utilization (the ratio of resources used to total resources available for production) and labor participation rates (the ratio of employed workers to total workers able to work), two primary factors that determine potential output, both have yet to recover to pre-pandemic levels. Although it is not necessary that they do so--certainly, all corporations can decide to idle plant permanently, and workers can decide never to rejoin the labor force--these types of large structural changes would have to be precipitated by correspondingly large social changes, and we don't yet see those in evidence as yet. Absent these, we are unable to conclude that actual output exceeds potential output, and therefore that price levels have achieved a higher long term rate of growth.

Excess Capacity Still Evident
Labor Pool Remains Deep

Add to the availability of excess capacity and labor 1. the increasing ubiquity of newly developed-but-previously-unadopted technologies, and 2. recent national investments in productive infrastructure, and you have the building blocks for long term productivity growth--and therefore the ability to hold rises in the general price level in check, or to drive them down even further, thus continuing the decades-long downward trend in the rate of change in inflation we've witnessed.

In the short term, we anticipate that inflation rates will continue to register higher-than-normal levels until supply chain disruptions moderate and more workers return to the workforce in the fall. Of course, the emergence of the Delta variant of the Coronavirus has slowed both inflation and growth over the last couple of months, so there remains considerable uncertainty about when or if these things might occur. Predictions are hard, especially about the future.

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