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This week I thought I’d write about a couple of investment jargon phrases that get thrown around by people like me, namely “stagflation” and “the Fed put”. Stagflation is where the economy is slowing but central banks (and this could be the US Fed or the Bank of England) can’t cut interest rates because inflation is too high. This is the world many feared we would be in at the end of 2022. In fact, for reasons that I think anyone has yet to properly understand, the global economy kept powering along and there was no real slowdown to deal with.
It looks to me like the risk of stagflation keeps falling. US inflation data was out this week and was pretty much in line with expectations (and if anything was a bit on the cooler side). There is reason to hope that the pick up in inflation we saw in Q1 will not repeat for the rest of the year. BCA Research have run the numbers and show that Q1 has been the hottest quarter of the year for inflation recently (which they think might be down to seasonal adjustment calculations not being quite right):
If this is the case, then central banks do now have the freedom to cut rates if and when the economy does start to slow. This is the so-called “Fed put”. I thought stagflation risks were pretty high in 2022 (and I thought a stagflationary world would be a real problem). I have much less time for the concept of the Fed put. The idea is that stocks can’t really fall much because if they do the Fed will just magically cut rates and make them go up again. My basic problem with this idea is that it is pretty obviously wrong. Equities and interest rates tend to both fall pretty hard into a recession. In 2007/8 US interest rates fell from over 5% to zero and equities fell over 30%. The Fed tried their best but their put just didn’t work!
In fact, I think the Fed put concept exists for a couple of different reasons. The first (and this is where I have been hearing it more recently) is used by investors to justify taking on a bit more risk today. Fair enough, central banks have more freedom to act now than in the past, but I am not sure a slowdown (which is what would make the Fed cut) would be good for equities. The current scenario of stronger growth and higher rates is fine for me!
The other reason you hear this concept is from (some) investors who are grumbling because they have missed out on an equity rally. The idea is that they were right, the economy was bad and equities should have gone down but the stupid Fed just bailed everyone out. This is similar to the people who sat out the equity bull market of the 2010s whilst complaining it was all down to money printing inflating asset prices. To these people I say the job is play the game with the world as it is not how you want it to be. The Fed are pretty open about what they are doing and why. If money printing is inflating asset prices, just buy the assets!
More charitably, market timing is hard. Sitting on the sidelines and waiting for a fall is – in my experience – harder to do than it sounds. The problem is not that markets fall (this is very normal!) but when they do those people sitting on the sidelines still don’t want to buy. Normally the market has fallen because the world has gotten worse: if you didn’t like it when times were good, why do you like it more when times are bad? I am not sure complaining about central banks gets you very far as an equity investor. The fact that inflation looks to be under control again is good for all investors and a reason to be more optimistic about the future. But that aside, I wouldn’t be using the Fed put as a concept to be putting on more equity risk today.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
