The Fed and inflation + other news

After our last news article which reported the rise of gold to record highs, but not inflation-adjusted records, this article will look at some of the biggest news stories of the week so far, and analyse them.

  1. The Fed is expected to make a major commitment to ramping up inflation soon – courtesy of CNBC

“In the next few months, the Federal Reserve will be solidifying a policy outline that would commit it to low rates for years as it pursues an agenda of higher inflation and a return to the full employment picture that vanished as the coronavirus pandemic hit.

Recent statements from Fed officials and analysis from market veterans and economists point to a move to “average inflation” targeting in which inflation above the central bank’s usual 2% target would be tolerated and even desired.

To achieve that goal, officials would pledge not to raise interest rates until both the inflation and employment targets are hit. With inflation now closer to 1% and the jobless rate higher than it has been since the Great Depression, the likelihood is that the Fed could need years to hit its targets.

The policy initiatives could be announced as soon as September. Addressing the issue last week, Fed Chairman Jerome Powell said only that a year-long examination of policy communication and implementation would be wrapped “in the near future.” The culmination of that process, which included public meetings and extensive discussions among Fed officials, is expected to be announced at or around the Federal Open Market Committee’s meeting.WATCH NOWVIDEO01:28US economy will be struggling against disinflationary pressures rather than inflationary, says Fed’s Powell

Markets are anticipating a Fed that would adopt an even more accommodative approach than it did during the Great Recession. 

“We remain firmly of the view that this is a deeply consequential shift, even if it is one that has been seeping into Fed decision-making for some time, that will shape a different Fed reaction function in this cycle than in the last,” Krishna Guha, head of global policy and central bank strategy at Evercore ISI. 

Indeed, Powell said the policy statement will be “really codifying the way we’re already acting with our policies. To a large extent, we’re already doing the things that are in there.”

Guha, though, said the approach “would be sharply more dovish even than the strategy followed by the [Janet] Yellen Fed” when the central bank held rates near zero for six years even after the end of the Great Recession.

All-in on inflation

One implication is that the Fed would be slower to tighten policy when it sees inflation rising. 

Powell and his colleagues came under fire in 2018 when they enacted a series of rate increases that eventually had to be rolled back. The Fed’s benchmark overnight lending rate is now targeted at zero, where it moved in the early days of the pandemic.

The Fed and other global central banks have been trying to gin up inflation for years under the reasoning that a low level of price appreciation is healthy for a growing economy. They also worry that low inflation is a problem that feeds on itself, keeping interest rates low and giving policymakers little wiggle room to ease policy during downturns.

In the latest shot at getting inflation going, the Fed would commit to enhanced “forward guidance,” or a commitment not to raise rates until its benchmarks are hit and, in the case of inflation, perhaps exceeded.

In recent days, Fed regional presidents Robert Kaplan of Dallas and Charles Evans of Chicago have expressed varying levels of support for enhanced guidance. Evans in particular said he would like to keep rates where they are until inflation gets up around 2.5%, which it has not been for most of the past decade.

“We believe that the Fed publicly would welcome inflation in a range of 2% up to 4% as a long overdue offset to inflation running below 2% for so long in the past,” said Ed Yardeni, head of Yardeni Research. 

The market weighs in

The investing implications are substantial.

Yardeni said the approach would be “wildly bullish” for alternative asset classes and in particular growth stocks and precious metals like gold and silver. Guha said the Fed’s moves would see “real yields persistently lower, the dollar lower, volatility lower, credit spreads lower and equities higher.”

Investors have been making heavy bets that would be consistent with inflation: record highs in gold, sharp declines in the U.S. dollar and a rush into TIPS, or Treasury Inflation Protected Securities. TIPS funds have seen six consecutive weeks of net inflows of investor cash, including $1.9 billion and $1.5 billion respectively during the weeks of June 24 and July 1 and $271 million for the week ended July 29, according to Refinitiv.

Still, the Fed’s poor record in reaching its inflation target is raising doubts.

“If there’s any lesson that should have been learned by all the world’s central banks it’s that picking an inflation target is easy. Trying to actually get there is extraordinarily difficult,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “Just manipulating interest rates doesn’t mean you get to some finger-in-the-air inflation rate that you choose.”

Boockvar doubts the wisdom of wanting to crank up inflation at a time when unemployment is so high and the economic recovery in jeopardy

“It doesn’t make any economic sense whatsoever,” he said. “The consumer is very fragile right now. The last thing we should be shooting for is a higher cost of living.”

Analyses of first article:

The markets might breath a sigh of relief that the Fed will have a looser monetary policy for longer.

People should never trade the markets based on the central banks and nobody can predict what will happen, short-term, with stocks.

This looser policy, however, might support inflationary assets like stocks because where else can people put their money if interest rates will remain at 0% for longer, and with higher inflation maybe on the horizon?

If the USD finally gives up its strength of the last ten years, that will also support the markets relative to bonds.

2. Coronavirus: Crisis-hit Virgin Atlantic files for bankruptcy via the BBC.

Virgin Atlantic has filed for bankruptcy in the US as the global aviation industry feels the impact of the coronavirus pandemic.

The UK-based airline is seeking protection under chapter 15 of the US bankruptcy code, which allows a foreign debtor to shield assets in the country.

It is the second Virgin-branded airline to struggle this year. Virgin Australia went into administration in April.

Meanwhile, Virgin Australia’s new owner Bain Capital is set to cut 3,000 jobs.

Virgin Atlantic’s US bankruptcy court filing said it had negotiated a deal with stakeholders “for a consensual recapitalization” that will get debt off its balance sheet and “immediately position it for sustainable long-term growth”.

The move comes less than a month after the company said it had agreed a rescue deal to secure its future beyond the coronavirus crisis.

Under that plan Richard Branson’s Virgin Group injected £200m, with additional funds provided by investors and creditors.

The billionaire Virgin boss had a request for UK government money rejected, leaving the airline in a race against time to secure new investment.

The US filing is tied to a separate action filed in a British court, where Virgin Atlantic obtained approval on Tuesday to convene meetings of affected creditors to vote on the plan on 25 August.

Virgin Australia cuts

Meanwhile, Virgin Australia’s new owner, the US private equity group Bain Capital, said it will cut 3,000 jobs, which is about a third of the airline’s employees.

The turnaround plan for Australia’s second largest airline will also see it retire the budget brand Tigerair.

“Working with Bain Capital, we will accelerate our plan to deliver a strong future in a challenging domestic and global aviation market,” Virgin Australia’s chief executive Paul Scurrah said.

In April, Virgin Australia went into voluntarily redundancy making it Australia’s first big corporate casualty of the coronavirus pandemic.

The following month it was bought by Bain Capital, which said it supported the airline’s current management team and its turnaround plan for the business. 

Bain also promised a “significant injection of capital” that would help Virgin Australia recapitalise and retain thousands of jobs.

Carriers around the world are struggling as they deal with the severe plunge in air travel caused by the coronavirus pandemic.

The International Air Transport Association warned in June that the slump will drive airline losses of more than $84bn (£64bn) this year.

Analysis of article 2.

The situation for the airline industry is grave and isn’t looking up anytime soon.

People should avoid investing in sectors like the airlines, or indeed any stocks which are heavily dependent on US-China relations like Chinese tech firms , just because the price is lower compared to a year ago.

That doesn’t mean that the price can’t go up, but it is a big speculation and gamble investing at this stage,.

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