The 1965 analog ...
We’ve all heard of various market analogs which are inherently dependent on ‘its NEVER different this time’ and each of them has their own individual merits.
Recently I noted // mentioned BRAINards words as they related to capping the yield curve **IF** rates were to go up too high too fast. Her modern day words of actions to be taken have roots in financial markets history
The latest analog which reminds us if we do not remember and study our nations (financial markets) past, we’re doomed to repeat it, comes from former Federal Reserve Bank of Minneapolis (2009 - 2015) president, Narayana Kocherlakota via Bloomberg OpED pages.
The Federal Reserve Faces a Troubling 1965 Parallel
The inflationary experience of the 1970s had its roots in the previous decade.
…The economic situation has changed dramatically over the past year. In December 2020, inflationary pressures were muted, as they had been for much of the preceding decade: The Fed’s preferred measure of consumer prices — the core index for personal consumption expenditures – was up just 1.5% from a year earlier. Now, core PCE inflation is running at 4.1% (as of the latest reading in October), more than double the central bank’s target and the fastest pace in more than three decades.
This kind of rapid shift has a troubling historical parallel. At the beginning of 1965, too, the Fed had little reason to be concerned about inflation – until the federal government greatly expanded the scope of the U.S. engagement in Vietnam. The extra demand pushed the core PCE inflation rate rapidly upward. In principle, the impulse from the added spending should have been temporary, but it fostered an inflationary psychology in which prices and wages began to rise in anticipation of future price and wage increases.
For years, the Fed failed to respond aggressively enough to this self-reinforcing upward spiral. As a result, inflation soared into the double digits by the end of the 1970s. Only by subjecting the U.S. to a brutal recession with double-digit unemployment was the Fed ultimately able to bring prices back under control.
The risk of this same kind of inflationary psychology is evident today. Pay is rising sharply: In the third quarter of 2021, private-industry wages and salaries were up 4.6% from a year earlier, more than at any point this century. The Federal Reserve Bank of Atlanta’s “sticky price index,” which measures prices that change infrequently, has also risen sharply — suggesting that merchants who set their prices for many months at a time expect high inflation to persist.
To address the threat of rising inflationary expectations, the Fed must act quickly and aggressively. Specifically, it should be prepared to initiate a sequence of meeting-by-meeting rate increases in the first half of next year, and to keep going until inflation comes back down near 2%. Such a steep path of tightening could take short-term interest rates well above the 2.5% level that Fed officials consider to be “neutral,” far higher than what they’re currently forecasting. This would come as a shock to markets and would entail some immediate economic pain. But it would eliminate the risk of a lot more pain in the future.
Emphasis mine. That very last sentence is where money is to be made and lost, at least in the ‘betting markets’ (short-term ie Eurodollars — outright, curves and options, etc as well as longer-term expressions such as 2s5s, 5s30s and 30yy outright).
They say that — in theory — ALL opinions are created equally. We know that — in practice — some opinions are more equal than others.
Thoughts?