What if the Fed abandons its inflation target of 2%?
Several people with big microphones are asking the above question in these times of stubbornly high prices.
In a piece entitled “Inflation,” dated March 2022, we asked a rhetorical question; “Could rising inflation along with rising Treasury yields trigger the end of the longest secular bull market in stocks and bonds?
In other words, will inflation prick the everything bubble?” Darren Winters wrote.
Fast forward two years, and we know the answer.
Last year, in 2022, approximately 30 trillion dollars was wiped off portfolio assets, with treasuries posting their worst on record, worse than the great depression.
Some of you may recall how Fed chair Powell was downplaying inflation at the time, as he argued the case of transient inflation.
“You can only go out to dinner once per night,” said Fed Chair Powell.
So, service sector demand in the post-pandemic economy is likely to normalize swiftly, he argued.
Put another way, the Fed believed that transient inflation caused by pent-up demand for services was no big deal and prices would normalize.
But it is not demand-pull inflation that investors are worried about, as it is the monetary inflation type that investors are fretting over.
“You can only go out to dinner once per night”
Fed Chair Powell
If the Fed was wrong about inflation, maybe they need to evaluate their inflation target of 2% higher
Admittedly the geopolitical black swan event, the rolling across the border of Russian tanks into Ukrainian in February 2022, completely threw out inflation calculations.
Ukraine is the third largest producer of grain in the world, so the Ukrainian war has impacted global food prices.
The blowing up of the Nord Stream pipeline in the Baltic, an alleged retaliatory act for the Russian invasion, has impacted global energy prices.
So few would have predicted a massive war in Eastern Europe, and even fewer would believe that this long bloody war would last more than one year with tremendous human cost; 150,000 dead and wounded, 8.1 million Ukrainian refugees, tens of thousands of orphan children, billions of dollars of wrecked infrastructure.
Ukraine is destroyed, bleeds dry, and led to its destruction by a comedian who dances in stilettos.
A rational leader would have realized fighting Russia is futile and that it is better to save the nation by making peace with Slavic big brother in the East.
The conclusion to the war in Europe has implications for inflation, which could also influence the Fed’s inflation target.
“The blowing up of the Nord Stream pipeline in the Baltic, an alleged retaliatory act for the Russian invasion, has impacted global energy prices”
How will this war in Eastern Europe end?
Will, what remains of the Ukrainian army and its people turn on Zelensky, and will he get the Mussolini treatment?
If so, putting Ukraine into Russian orbit could be the geopolitical event marking the beginning of a multipolar world where great power politics shape and divide the world.
But the end of US hegemony could weaken the US dollar as the world reserve currency as countries make bilateral trade agreements outside US world trade rules and the US dollar.
Brazil is buying Saudi oil in a deal known as the Petrobras.
Russia currently exports 90% of its oil to China and India outside the US dollar.
“India’s trade volume with Russia reached a record 38.4 billion dollars in 2022” – Win Investing
Russian trade with Egypt rose by 30%, primarily in the weapon system, in 2022. Algeria is also one of Russia’s biggest trading partners on the African continent, with trade reaching US$3 billion in 2022.
Russian exports to Morocco doubled last year, while bilateral trade has reached US$1.2 billion and will boost its Agro-food exports to Morocco by a multiple of ten during 2023-24.
Iran’s trade with Russia increased by 20% in 2022 and is expected to rise to $40 bln in the coming years.
India’s trade volume with Russia reached a record 38.4 billion dollars in 2022.
A growing volume of global economic activity is moving to the East, away from a dollar-centric world. If the BRICS launch a commodity-based currency and form a military alliance, China and India’s largest armies in the world and Russia’s largest nuclear power could weaken US hegemony and rattle the US dollar throne.
“A leaked report, which many already quietly suspected, said that when war broke out last February, UK US special forces were already operating in Ukraine” – Win Investing
De-dollarisation could force the Fed to raise its inflation target
As the world order cycle shifts from unilateralism to multilateralism, global demand for US dollars could decline, which is inflationary for the US economy, and could force the Fed to raise its inflation target.
Alternatively, the Ukrainian war could be about to escalate, with NATO officially joining the war, in what would be a WW3 scenario.
The US proxy war with Russia started in 2014, as NATO trained Ukrainian forces to fight Russia. The Minsk Agreement, A Russian peace plan for Ukraine, was not taken seriously by the West.
A leaked report, which many already quietly suspected, said that when war broke out last February, UK US special forces were already operating in Ukraine.
So when Ukraine looks spent and ready to capitulate, NATO enters the war. Such a scenario could trigger a flight to safety. Typically, that means capital flows into safe-haven assets, treasuries, precious metals, and USD.
If so, treasuries would rally, and yields would fall.
But a major war is also inflationary, which could force the Fed to raise its inflation target.
In another scenario, public opinion against war grows in Russia, and Putin is removed from power in a military coup d’etat.
What if the new leader is more radical and eager to use nuclear weapons?
So many things hinge on how the conclusion to the war in Eastern Europe, and it makes inflation seem insignificant, but the outcome will affect the Fed’s inflation target.
With so much disinformation, bearing in mind truth is the first casualty of war, that makes speculating about the outcome difficult.
But one thing is certain, we live in historical times, whatever the outcome.
If the Fed decides to raise the inflation target to 4%, which we believe they may do, yields could rise.