Differences in inflation dynamics between the post-pandemic period and the global financial crisis have implications for future monetary policy and risk of the Fed falling behind the inflation curve.
Markets have become increasingly sensitive to even small policy changes in the post-QE era, raising concerns about the potential impact of the Fed's attempt to normalize policy.
The resignations of senior policy makers and potential changes in Fed leadership highlight the importance of having experts in managing bonds and investment banking to effectively navigate monetary policy and manage market volatility.
Deep dives
Changes in inflation outlook
The podcast discusses how the understanding of inflation in a post-pandemic world differs from the global financial crisis (GFC). While the GFC led to disinflation and negative productivity shock, the pandemic has caused a positive supply shock in certain sectors, along with supply chain restructuring. This difference in inflation dynamics has implications for future monetary policy and the potential risk of the Fed falling behind the inflation curve.
Risk-off resulting from Fed's policy normalization
The podcast explores the inevitability of a risk-off event stemming from the Fed's attempt to normalize policy. It is suggested that markets have become increasingly sensitive to even small policy changes in the post-QE era, raising concerns about the potential impact of Fed actions. The discussion also touches upon the importance of understanding the differences between post-GFC and post-pandemic policy, highlighting the potential challenges for policymakers in managing market volatility.
Implications of Fed leadership and recent resignations
The resignations of senior policy makers and potential changes in Fed leadership are discussed in the podcast. It is noted that there is limited capital market experience within the current Fed members, and the importance of having experts in managing bonds and investment banking to effectively navigate monetary policy is emphasized. While the short-term consequences of these resignations may create market uncertainty, the overall focus is on the future course of Fed policy and potential implications for the inflation outlook.
Valuation metrics and investment positioning
The podcast considers the valuation metrics and investment positioning in the current market. It highlights that certain sectors, such as financially sensitive sectors and energy, appear relatively cheaper and have the potential to perform well in a reflationary environment. It is noted that while valuation metrics may currently be elevated, strong underlying economic support and potential earnings growth could help sustain higher valuations. The importance of managing risk and understanding the potential impact of Fed policies on asset prices is also emphasized.
Outlook for wage growth and corporate behavior
The podcast discusses the outlook for wage growth and its impact on corporate behavior. It suggests that wage disinflation, particularly in economically sensitive sectors, has bottomed out and wage growth is expected to rise, along with increasing inflationary pressures. The potential implications of wage dynamics on corporate profitability and the ability of companies to adapt to inflationary pressures are explored. It is noted that while wages are expected to rise, the pace and persistence of wage growth will determine the overall impact on corporate performance.
For the landscape of elevated asset prices that defines today, nothing may be more consequential than changes in the inflation outlook. And for Barry Knapp, the founder of Ironsides Macro, the Fed is off-track with respect to its understanding of inflation in a post-pandemic world. While the Covid shock brought market volatility comparable to the breathtaking levels experienced during the GFC, the inflation aftermath of these two crises could not be any different. In Barry’s rendering, while the GFC left household and financial sector balance sheets in disarray amid a damaged credit channel, consumer leverage is extremely low and lending is unimpaired in the post pandemic period. By crafting today’s policy as a function of the disinflationary decade post 2008, the Fed also fails to account for the positive supply shock in energy that was the Shale revolution as well as the decades long period of goods disinflation that resulted from China’s admission to the WTO. The result, especially as supply chains are being restructured, is the risk that the Fed runs consistently behind the curve over the coming year. As our discussion continues, Barry shares his views on the inevitability of a risk-off resulting from the Fed’s attempt to normalize policy, a consequence of the degree to which market prices have become increasingly sensitive to even small policy changes in the post-QE era. I hope you enjoy this episode of the Alpha Exchange, my conversation with Barry Knapp.
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