Jerome Powell and the rest of his Federal Reserve Board Members face tough decisions in 2023 as structural supply chain challenges keep inflation rates intolerably high. Looking at two previous Fed chairs, we have to decide who will provide the precedent for Jerome’s decisions in 2023.
Meet Arthur Burns
In the late 1970’s, Fed Chairman Arthur Burns decided to take a “pause and hold” approach during a supply-driven inflation shock. Every time he paused, inflation spiked. His whole monetary policy was a disaster and over many years it kept shrinking S&P multiples and turned into 10-year long bear market. An extremely painful environment for a very long time for portfolios and retirement accounts in general.
Meet Paul Volcker
Paul Volcker replaced Burns and in 1979 he said “to hell with all this I am just going to raise rates so fast to intentionally crush the economy into a deep recession.” From 1979 to 1981 he raised fed funds rate by 880 bps! A severe recession followed in January 1980 but he didn’t care and kept hiking. Manufacturing sector lost 1.1 million jobs, automotive sector lost 33% of entire workforce (about 310,000 jobs), construction sector lost 300,000 jobs. Unemployment rate went to 8%. Unemployment in auto sector went to 24.7% and in construction sector went to 16.3%. Extremely painful but he killed the inflation. Then came Ronald Reagan tax cuts and other forms of fiscal stimulus and boom we had years of strong bull market.
Fed Messaging
The Financial Times reports today what we have said recently during our recent Friday Investment Talks: Fed Fund rates are going at least 50bps higher and, most importantly, will stay at those levels thru all of 2023.
In reality it probably doesn’t matter if Powell is more like Burns or Volcker. Neither scenario made investors happy as it inflicted a tremendous amount of pain on equity market valuation. If history is any guide we could very possibly see the same play out in 2023. This is what happens when you try to shrink the economy to “right-size it” with interest rates policy, when in reality solutions should come from government policy makers that can affect the structural dynamics of inflation.