Has the Fed lost the plot?

Dustin Reid, vice-president, investment management with the fixed income team at Mackenzie Investments, said the Fed reacted slowly to initial signs of trouble in the economy, misread the essential nature of inflation, and sent mixed signals to markets in recent months.

The most recent red flag, he said, was Federal Reserve Board chairman Jerome Powell’s inability to assure a questioner at a recent press conference that he expects a soft landing.

“Powell, for the first time in this cycle, I thought, really sidestepped the question,” he said. “It’s interesting when the Fed thinks they may have lost the plot a little bit on what they were trying to engineer.”

Reid said the recent bank collapses created volatility in the financial sector, and money supply will continue to be an important variable. If credit remains available and relatively easy to obtain, a recession could be minimized or even avoided entirely.

“If the credit transmission mechanism dries up, for whatever reason, but in particular on the credit side because of what we’ve seen over last few weeks, then that clearly risks … hard-landing territory.”

Ultimately, inflation is the principal hurdle for economies around the globe, Reid said, and in North America market characterization of the problem has morphed several times.

“In 2021, we liked the term ‘level up,’ i.e., inflation was going to be running at a higher level for a while. Then we kind of migrated from ‘level up’ to ‘sticky.’ … And then ‘sticky’ to ‘structural,’ i.e., a little more ingrained,” he said. “And I think we’re there.”

The Fed appears to be using personal consumption expenditures and “core services ex shelter” statistics as its guide for gauging inflation. On a three-month annualized basis, core services ex shelter is still accelerating, and the labour market remains hot.

“The Fed is still worried about that. And that’s one of the reasons I think why the Fed has continued to its hiking cycle,” Reid said.

Reid said the Bank of Canada appears to be looking primarily at the consumer price index as it shepherds the economy.“The U.S. household really de-levered after 2007, ’08, ’09, and the Canadian household did not,” he said. “The Bank of Canada is very aware of that and has been trying to manage that.”

When it comes to interest rate moves, he said, the Bank of Canada appears to be on hold for the moment.

“I think the Bank wants to be done. The operative word being ‘wants,’” he said. “The market is actually pricing in some rate easing relatively soon, maybe even before the second half of the year. But, barring some sort of financial industry negative event, I think that the bank will be on hold at least through the summer, into Q3 and maybe beyond.”

Reid said the global macro environment makes fixed income look “really, really interesting,” both from an economic and a trading perspective for the balance of 2023 and moving into 2024.

“While I think central banks are close to the end of the hiking cycle, this stickiness and inflation may result in [another hiking round]. So, there’s a trade to be had for now, I think, on the steepener side.”

His advice to advisors is to be nimble and to consider information both from analysts about how the economy is progressing and from governments about how policy may evolve.

“Don’t be married to a view that you just think has to be fundamentally true,” he said. “The news flow and market sentiment and positioning can change very, very quickly.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.