Bond Bulls And Banana Republics

As regular readers know all too well, I harbor something that looks (and feels) quite a lot like cognitive dissonance when it comes to inflation fault-finding.

Who gets the blame for inflation in these pages depends in part on what kind of mood I’m in on any given day. Please don’t misconstrue that. It’s not as capricious as it sounds.

There’s no one “truth” when it comes to assigning blame for this generation’s inflation crisis. Anyone who claims it’s possible to identify the one proximate cause of the problem is either intellectually bereft, lying or, in some cases, both.

Inflation à la 2021/2022 has myriad ingredients, all of which can be subsumed under one of three categories: Supply factors, demand factors and policy factors. Monetary policymakers can’t easily impact supply factors and politicians’ efforts in that regard are plagued by spite, political expediency, incompetence and genuine, real-world constraints. So, one way or another, policy factors work through the demand channel, either by juicing it or, now, dousing it.

When I’m feeling analytical, I quantify the contribution of supply versus demand factors. That exercise invariably suggests that the former are more important than the latter (figure below), and I assign blame accordingly in a dry, measured cadence.

On days when I decide central banks and fiscal largesse are perhaps enjoying too much of a reprieve, I remind market participants that no matter how forgiving you’re inclined to be in light of the indeterminacy facing policymakers in March and April of 2020, there’s little question that we overcompensated.

Of course, it’s disingenuous to suggest anyone “should’ve known better.” It’s often quite difficult to know what’s “rational” and what isn’t without the benefit of hindsight. When it comes to the pandemic policy response, it’s infinitely easier to use words like “overcompensated” now that we’re mostly safe, with vaccines and therapeutics in-hand.

Finally, there are days when I’m simply exhausted by what I view as a wholly dishonest attempt on the part of Fed critics to deny reality. As I put it late last month, if there’s not enough natural gas or not enough oil or not enough refining capacity for the oil we do have or not enough wheat or not enough logistical wherewithal to get the wheat where it needs to go and so on, then there’s not enough. Period. You can exacerbate a supply problem by turbocharging demand, thereby straining both sides of the equation. And we unquestionably did that. But it’s still a supply problem.

As someone who spends his days engaged in an around-the-clock effort to present all sides of important macroeconomic and geopolitical debates in an evenhanded way (except in circumstance that simply don’t admit of evenhandedness), it vexes me greatly when others don’t aspire to the same level of impartiality.

Enter Hoisington’s latest quarterly review and outlook piece published… I don’t know, sometime this month, although it’s hard to be sure because the firm’s 90s-style website (“Look how quaint we are!”) makes it difficult to determine when, exactly, content was made public. (There’s a “Date page was last edited” stamp, but that’s about it.)

Sometimes, I can countenance Hoisington’s quarterlies despite the fact that, without exception, they’re little more than short summaries of recent macro events seasoned with bitter-tasting derision and paint-by-number FRED charts, only without the paint (they’re black and white). There’s never anything new or novel about them, and the conclusion is (almost) always the same: Treasurys should, or at least could, rally.

If you’ve ever read a Hoisington quarterly review, you’re laughing by now, because that description is as brutal as it is accurate. The latest installment follows the same template (I imagine it probably is a template, maybe saved on WordPerfect), but it starts on a particularly abrasive note, even as passive aggressive Hoisington reviews go.

The Fed, Hoisington said, was “constructed to prevent the central bank of the United States from acting like a banana republic central bank.” Implicit (and mostly explicit) was the notion that the Fed did, in fact, morph into a banana republic central bank during the pandemic.

As usual, I agree with some (many, even) of Hoisington’s arguments. If their color weren’t so colorless and if I were delusional enough to believe Hoisington has ever found their way to my writings (I can assure you they haven’t), I’d be inclined to suggest that they, like a handful of outlets whose journalists and bloggers actually do frequent these pages on the way to parroting my talking points and cadence (without attribution), were drawing inspiration from my musings.

What I don’t agree with, though, is the implication that browbeating people with paraphrased Milton Friedman quotables is useful, nor do I think it’s particularly helpful to advocate for the adoption of any strict limits on money supply growth, knowing full well that such ideas sound much better on paper than they work in reality.

Like all Hoisington quarterlies, the firm’s latest is likely to please fans and it’s accessible to general audiences, to the extent such missives can be. But also like all Hoisington quarterlies, no dedicated market observer can learn a single new thing from it. It’s written by a PhD, but it could’ve been an undergraduate paper cobbled together from Wikipedia and Bloomberg macro headlines.

At this point, you might be asking yourself “Why?” “Why be this hard on an innocent Hoisington quarterly?”

The answer is that, in my opinion, it’s not totally innocent. The firm wrote that,

[The] Fed’s low rate policy was very slow to change even though the actual increase in their preferred inflation measure surged to more than triple the upper limit of their target. Thus, the Fed continued to create demand, i.e., to shift the Aggregate Demand curve outward, while doing nothing to lift the Aggregate Supply (AS) curve upward. Indeed, supply chain disruptions from the pandemic, aggravated by the Russian invasion of Ukraine, shifted the AS curve inward, exacerbating the monetary-induced price surge.

That excerpt is, in my judgment, highly misleading. PCE inflation didn’t surge to triple the Fed’s target because monetary policy created too much demand for food and gas. Notwithstanding America’s obesity epidemic and absurd affinity for tank-sized, gas-guzzling SUVs, people can only eat and drive so much.

Yes, voracious demand for goods (turbocharged by fiscal transfers and the wealth effect from rising stock and property prices) creates knock-on demand for energy (and particularly oil), but that’s not why headline inflation catapulted into the stratosphere. What we know now, with the benefit of hindsight, is that headline inflation would be elevated today irrespective of monetary policy.

Outside of a hypothetical scenario where the Fed did absolutely nothing in March of 2020 (and I doubt seriously that Hoisington would suggest a hands-off approach was preferable in the early days of the pandemic), we can rule out the kind of across-the-board demand destruction that would’ve been necessary to offset the inflationary impulse from supply chain disruptions, vaccine success and the eventual re-opening of major economies made possible by a historic global inoculation drive.

There are two alternate realities in which headline inflation isn’t elevated right now. In one, policymakers did nothing in March of 2020 and the world succumbed to a depression. In another, COVID was more Ebola and less flu, and we’re all too busy being dead to worry about headline inflation, to say nothing of core.

Absent those objectively poor outcomes, headline inflation was going up one way or another. Hoisington has it backwards. Policy largesse exacerbated a supply-induced price surge, not the other way around.

That’s a critical distinction not just because we need to determine where things went wrong, but also because when you’re indicting someone (figuratively in this case) for a wrong done to the public, it matters tremendously whether that person (or institution) was the proximate cause of the harm or merely an enabler.

Hoisington clearly believes the Fed was the source of the problem. Indeed, the firm suggested the Fed acted outside of its charter over the past two years. Going forward, policymakers’ dilemma is stark, Hoisington said. “If the Fed stays within the scope of the Federal Reserve Acts, they will have difficulty in containing the recession and fostering a recovery, but that situation puts us on alert to the possibility that the Fed returns to a pandemic-type of response that generated an inflation rate far above their target, as the experience of the past two years has so painfully taught,” the firm wrote.

You know, it’s interesting: The mechanics of QE didn’t change in 2020. On and off for a dozen years prior to COVID, the US bought bonds from itself via arm’s length bank intermediaries. Until the pandemic, that circular funding scheme never facilitated runaway inflation in the real economy, something Hoisington, the biggest bond bulls on Earth, know all too well.

And yet, we’re supposed to believe that the exact same scheme was the proximate cause (as opposed to an enabler) of inflation in 2021 and 2022. Why? Because the government outlays it funded were concurrent such that a chart showing the deficit versus the Fed’s ballooning balance sheet was funnier than it was previously? Maybe.

My guess, though, is that headline inflation would be high regardless. You can’t “QE ships,” as an already tired joke goes, but as I reminded readers last month, you can’t “rate hike” them either. The point: Logistical hangups tied to the pandemic would be a fact of life regardless of monetary policy settings, and those hangups would’ve pushed up inflation in any scenario. More obvious still, headline inflation is heavily influenced by commodities, which just experienced one of the most volatile episodes in modern history. The fireworks crescendoed this year in a dizzying ascent to record highs for a laundry list of critical raw materials. Again: Headline inflation was going up regardless.

But who am I, right? As one reader put it in an irritated email a few years back, Lacy Hunt has probably forgotten more than I’ll ever know.

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