The Fed is stuck between a rock and a hard place.  They are responsible for maintaining stable prices and yet are somewhat powerless to affect the supply chain and labor shortage-induced inflation pressures with monetary policy.  While it could certainly be argued that printing $120 billion a month with inflation pressures mounting is akin to pouring fuel on the fire, the super glut of cash already in the financial system mutes the impact from tapering.  Cash with nowhere to go finds its way to the Fed’s repo facility and it just keeps piling up and with $1.4 trillion accumulating since around April.

The Fed missed its window for monetary policy to have much impact and now needs to play catch up or at the very least appear to be more realistic regarding inflation.  It’s disappointing and even comical to hear members of the Fed and even some economists claim that inflation pressures are more than anyone expected when many (us included) have been calling for shortages to continue to steadily worsen at least through the year-end holiday shopping season since last spring.  And it doesn’t take a rocket scientist to understand why Canada is back to full pre-pandemic employment while the U.S. is still 4 to 5 million jobs below pre-pandemic levels of jobs nor difficult to predict the challenges posed by the ensuing labor shortage.  Of course, they knew but couldn’t admit it and so “transitory” was born.

Ironically, the Fed is addressing inflation pressures caused by too few workers by removing stimulus when they would typically be trying to enhance employment by stimulating the economy.  But since there are so many jobs going unfilled, the Fed resorts to strategies that would reduce demand; not that it will make a difference given that there is so much pent-up demand and excess savings.  Inflation itself has become the most powerful impact on consumption as it both destroys pent-up savings and stimulates early buying of goods “before they run out!”.  The saddest effect from the surge of inflation is that even if it is a one-time temporary year-over-year hit of 7%, that equates to about 3 years of lost real economic growth assuming a 2% to 2.5% annual GDP.  The Fed will likely be the scapegoat when common sense dictates that Congress should take the lion’s share of the blame.

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Author Portrait
Bryce Doty is a Senior Vice President with Sit Fixed Income and Senior Portfolio Manager of the taxable bond portfolios for the firm’s custom separately-managed accounts, private investment funds, and mutual funds. Bryce oversees the firm’s team of taxable bond managers, analysts, and traders.