Deep Thoughts, By Bill Ackman

Bill Ackman did some thinking over the weekend, and like all great thinkers before him, he chose Twitter when the time came to share his Jack Handey moment with the public.

“While it has become conventional wisdom that the @federalreserve will raise rates 3 to 4 times this year to mitigate inflation, the market expects 25bps increments,” he said. “The unresolved elephant in the room is the loss of the Fed’s perceived credibility as an inflation fighter and whether 3 to 4 would therefore be enough.”

I should note a few things. First, “conventional wisdom” probably isn’t the best way to describe market pricing for rate hikes. It works, but it’s suboptimal. “Conventional wisdom” is best used with old adages and proverbs, not policy expectations as manifested in swaps and futures. Second, you don’t “resolve” an elephant in the room, you address it. Apparently, Ackman is the Thomas Friedman of hedge fund managers.

Having (clumsily) set the stage, Ackman made the case for carpet-bombing the expectations channel. “The @federalreserve could work to restore its credibility with an initial 50bps surprise move to shock and awe the market, which would demonstrate its resolve on inflation,” he wrote, adding that,

The Fed is losing the inflation battle and is behind where it needs to be, with painful economic consequences for the most vulnerable. A 50bps initial move would have the reflexive effect of reducing inflation expectations, which would moderate the need for more aggressive and economically painful steps in the future. Just a thought.

Yes, “just a thought.” And not a very good one. Or at least not as articulated.

It’s most assuredly the case that the Fed is behind the curve. As Charles Evans put it this week, Fed policy is “not well positioned” for inflation. As late as December, officials were still clinging to the notion that policy was “in a good place.” It wasn’t. And it’s not.

The problem (and I’ve been over this on countless occasions) is that the public doesn’t know enough about the Fed or what it does for rate hikes to affect the expectations channel in the short-term, especially when they commence from the zero lower bound.

Even if the Fed enlisted the media to raise public awareness around a “chunky” hike (i.e., a larger increment than 25bps), it’s unlikely to affect expectations at a time when a laundry list of more tangible factors are conspiring to push prices higher.

Plainly, the public does have something like an informed opinion on the issue given the divergence between short- and long-term inflation expectations (figure above).

My guess would be that the disparity is mostly attributable to blanket press coverage of supply chain issues and other pandemic distortions, which consumers rationally expect to abate over time, not to the public’s faith in the Fed to bring down inflation if we just give them a year or two.

None of that is to say the Fed shouldn’t raise rates. And, as I suggested in “Something Wicked This Way Comes,” there’s obviously some truth to the notion that the economy is overheating and that too much stimulus, both monetary and fiscal, was the catalyst.

But at the end of the day, Americans aren’t informed by careful consideration of existing policy. If they were, they’d have recognized the Trump tax cuts as a handout to the wealthy and a (successful) effort to deliver a windfall to corporate America (figure below).

Generally speaking, voters still don’t understand the extent to which the 2017 tax overhaul was a giveaway to the rich.

The point is, the American public doesn’t do a lot of thinking and isn’t fond of analysis. You can’t alter their expectations with policy tweaks, the effects of which may take months (or even years) to manifest in real economic outcomes.

A 50bps rate hike still counts as a policy tweak. “Shock and awe” would be a 4% rate hike. That would affect expectations virtually overnight, because it would ripple through global markets, likely to disastrous effect, and might well push the economy into a recession within a month.

Of course, that isn’t going to happen because, to quote Ackman, it would have “painful economic consequences for the most vulnerable.”

At the end of the day, this is a very difficult situation for the Fed and the Biden administration. It’s tempting to chastise the bureaucrats, technocrats and policymakers. But, to quote the above-mentioned Handey,

Before you criticize someone, walk a mile in their shoes. That way, you’ll be a mile from them, and you’ll have their shoes.