FEATURED

June 21,2022

Everybody and his uncle is now looking for the entry level to the next bull market. The Goldman Sachs team recently wrote a “Recession Manual for US Equities.”

• GS: “Across 12 recessions since World War II, the S&P 500 index has contracted from peak to trough by a median of 24%. A decline of this magnitude from the S&P 500 peak of nearly 4800 in January 2022 would bring the S&P 500 to approximately 3650. The average decline of 30% would reduce the S&P 500 to 3360.”

Not to be outdone, BofA’s Michael Harnett identified 19 U.S. equity bear markets over the past 140 years: average price decline = 37.3% and average duration 289 days. That puts us at 3000 around October 19th 2022.

The reality is that no bear is really similar: different causes, different environment, different remedies, different outcomes. Like saying the average temperature in Canada is 65F. When? Where?

• GS: “Since 1948, S&P 500 earnings have dropped from peak to trough around recessions by a median of 13%. EPS have recovered by a median of 17% four quarters after troughing.”

The norm has been -10 to -15%, except in 2000-01 and 2008-09.

This is not a financial crisis à la 2008.

Could it be a 2000-01 type, given its tech-bubble-like nature, the similarly long economic cycle and a Fed also tightening?

In spite of the 9-year long cycle (averaging 3.8% GDP growth), there were no signs of inflation, stable around 2% until creeping up to 2.5% by mid-2000, right when the Fed stopped its “preemptive hikes” from 4.8% in June 1999 to 6.5%. The S&P 500 peaked in March 2000 and profits did so in September amid a strong economy. A light recession started in Q2 2001.

The S&P 500 index P/E was 24x forward EPS in March 2000 (these estimates proved to be 27% too high!) but its IT sector P/E, 29% of the index, was at 47x. In effect, ex-IT, equities were selling at 19.5x, down from 22 one year before.

The 1999 equity bubble was concentrated in technology stocks. Incredibly, the NASDAQ 100 index multiplied by 4.8x between 1998 and March 2000 to trade at 90+ times earnings. This while the S&P 500 rose 60% and the Russell 2000 only 13%. By comparison, from 2019, the NDX rose 165%, the SPX 92% and the Russell 2000 82% to their recent peak.

During 2000 the losses were understandably also concentrated in technology stocks. The NASDAQ fell by more than 75% between March 2000 and October 2002. Meanwhile, the S&P 500 lost 45% and the Russell 2000 index 36%.

But the bulk of NASDAQ’s losses occurred in 2000 (-51%) while the S&P lost only 15%. During 2001, losses expanded to the entire large cap sector. The S&P 500 cratered 38% through September 2002 even though the recession ended in November 2001 and profits bottomed out in December 2001.

In reality, this was a two-step bear market: the tech bubble explosion in 2000, a $5 trillion wipeout in a $10 trillion economy, caused a small recession in 2000.

Consumer expenditures bounced back in the first half of 2001 but the World Trade Center attacks in September 2001, the Enron/WorldCom debacles and some accounting scandals sent investors not to the sidelines but completely out of the stadium.

S&P 500 profits were down 31% YoY in December 2001 but economy-wide corporate profits declined only 12% in total during 2000 and 2001.

It thus seems appropriate to assume that, if a recession occurs, profits would likely decline by the “conventional” 10-15% from their current $218 (after Q2) level to around $191. That is unless something else happens.

• GS: “The S&P 500 forward P/E multiple has contracted by a median of 21% between its pre-recession peak and its eventual trough. During the typical recession since 1980, the index P/E multiple peaked 8 months in advance of the onset of a recession and declined by 15% between its pre-recession peak and the beginning of the recession.”

The S&P 500 forward P/E having peaked in March 2021 at 22.6, a 21% contraction would bring it to 17.8. It is now 15.6…but on forward earnings of $235. Using recessionary EPS of $191 times 17.8 = 3400. If the P/E contraction is 15%: 19.2x $191 = 3670.

Goldman’s analysis takes no account of inflation and its impact on equity valuation. In 1980-82, inflation was in double digits range, it fell in the 5% area in 1990 and 2.5% in 2000-02 and in the late 2000s. These were much different economic and financial environments.

The Rule of 20 takes inflation into account. Regardless of the cycles save the occasional bubble, the Rule of 20 P/E (actual P/E plus inflation) fluctuates between 16 and 24 with Fair Valuation at 20, where valuation upside (20%) equals valuation downside (20%).

It is now 23.2, down from 29 last December but still very expensive. Based on current estimates, EPS will reach $218 after Q2’22. At the 20 R20 P/E fair value (median of 16-24), using 6% inflation, the S&P would be at 3050. At a R20 P/E of 18 = 2600 (18 – 6 = 12 x $218).

The key is inflation: at 5% core inflation, fair value = 3270, at 4% = 3500 using $218 EPS.

These assume no recession which might take EPS close to $191 but would also likely result in lower inflation.

Using EPS of $191 (-12.5%), inflation at 3% = 3250. Inflation at 2% = 3440.

What all these numbers are saying is that current fair value would be between 2600 and 3500 depending on inflation which nobody can today realistically forecast.

They also say that recessionary conditions, bringing profits and inflation down, would narrow the range to 3270-3440, down 6-10% from current levels.

• GS: “Across the same 12 experiences since WWII, the equity market has begun to price a recession on average 7 months prior to the official start of the recession per NBER’s designation. In all but one instance, the sequence of events was the same: The market peaked prior to the recession and then bottomed prior to the end of the recession.

The 7-month average hides a range between 0 and 13 months. Equities peaked in January 2022. Q1 GDP was negative, Q2? The lead could thus be zero this time. If 7, then an August low, if 13, February 2023.

Similarly, and perhaps more useful, is the 13-month average duration from market peak to trough with a range of 1 to 30 and a median of 15. We are in the 5th month. 13 months = February. But if this is a true inflation fight, that took 21 and 20 months in 1973 and 1980 respectively = fall of 2023.

INFLATION, RECESSION, STAGFLATION…OR GOLDILOCKS

“It is difficult to make predictions, especially about the future.” (Mark Twain?, Yogi Berra?)

Yet, we’re all engaged in crystal balling, unless you abide by the Rule of 20 which only uses actual trailing earnings and inflation data, and buy and sell equities based on objective risk/reward measures. Based on current R20 metrics, this is still not the time to be over-exposed to equities.

But let’s venture some scenarios:

• The Good:

No recession in North-America as the known weak areas (housing, consumer goods, inventory liquidation, current account deficit, government disengagement, Fed QT, war, supply snags, stalled E.U., weaker China, etc.) are partially or fully offset by reshoring/nearshoring/friendshoring capex, rising farm income, higher energy investments/production/exports, goods deflation, 4-5% wage growth, etc.) Goldilocks perhaps! Not too hot, not too cold with inflation cresting shortly and easing in the second half. Seeing a slowing economy and lesser inflation, the Fed turns to neutral to see how things go. R20 fair value is around 3500 but valuations could stay higher than normal given the better environment. Risk on!

• The Bad:

Like above but a mild/short recession occurs in 2022. Profits decline 10% but inflation retreats to the 3% range as supply issues abate and energy prices decline. R20 fair value is 3330. Wait for the Fed signal (see below).

• The Ugly:

Stagflation or deep recession. Like “The Good” without most of the offsets or like “The Bad” without much disinflation. Total risk off, not knowing when and how this will end. When the Fed abdicates and morphs into its dovish creature, it will be time to re-enter.

TIMING CONSIDERATION

“Normally, the stock market struggled the most as inflation was moving up but did fantastic subsequent to the inflation peak — generally even in the event a recession materialized,” (James Paulsen, chief investment strategist, the Leuthold Group). Paulsen’s findings were based on an analysis of 17 prior “major” U.S. inflation peaks since 1940.

Here’s his tally via Axios:

Data: The Leuthold Group; Chart: Erin Davis/Axios Visuals

The little Ronald Reagan in me tends to “trust…, but verify”. It turns out that Paulsen was pretty loose with his “major” inflation spiking periods. The last 6 periods saw core inflation rather stable in the 2.0-2.5% range while in 1960, inflation peaked at 3.3% from 3.0%, not much of a spike.

But the record is quite good with 8 of the other 10 genuine peaks, having been followed by good equity markets, most very positive. Six were followed by recessions. Actually, 5 of the 6 were already in recession when inflation peaked. Only 1957 saw the recession begin 4 months later.

David Rosenberg assesses how low we can go?

Well, all the stock market has done in this first leg of the bear market is mean-revert the sky-high P/E multiple. But in bear markets, the trough multiple is 12x. And in recessions, corporate earnings decline by 23%, on average. Do the math — under the proviso that earnings and the multiple bottom simultaneously, we would be talking about 2,200 on the S&P 500. That isn’t a forecast as much as a mathematical construct. That indeed would represent a full 100% Fibonacci reversal. The next test, as an aside, is the 61.8% retracement, at 3,215 (after the latest violation of the 50% reversal level of 3,516).

A 12 trough multiple? Ed Yardeni would disagree, particularly when there is inflation. Since 1957, the average P/E at bear market lows was indeed 12.7, but with a range of 7.2 to 19.2:

Since 1942, the average is 11.7, but it’s also a useless camel that makes no bones of inflation!

strategasasset

As seen previously, recessions cut earnings 10 to 15%, except in special crisis like in 2000-01 and 2008-09.

So let’s do Rosie’s mathematical construct again, but using the Rule of 20 P/E. Taking inflation into account, the Rule of 20 sports a much more consistent “low low” around 15 (averaging 17.3).

But first we need an inflation rate. Given the assumed recession and based on history, core inflation could be cut in half from its current 6% rate. At 3% and a R20 P/E of 17.3 = 2700. If the Fed has its wishes, at 2% inflation = 2900.

In our risk assessment exercise, this 2700-2900 range registers as our worst case.

Since we can never know where the actual bottom will be, the Rule of 20 helps us objectively measure our risk/reward ratio. At any given time, a R20 P/E below 20 means that the valuation downside is lower than the valuation upside. At current EPS ($218 after the Q2 earnings season) and inflation (6.2%) levels, this “fair value” is 3000 (actual P/E of 20 – 6.2 = 13.8).

Briefly said, that means that, at current EPS and inflation levels, equities would only begin to provide a positive risk/reward ratio below 3000. Another way to say it is equities are still 18% overvalued given actual, known parameters.

This is a dynamic process. If analysts are right and EPS reach $224 after Q3 and inflation retreats to 5%, the R20 fair value would rise to 3360.

Inflation at 5% in the fall requires monthly core CPI prints averaging 0.3%. If 0.2% monthly, inflation would be 4.5% YoY in October and fair value would reach 3475.

THE CRITICAL FED  EFFECT

Inflation is the most crucial factor to watch in the second half of 2022. Falling inflation would help the R20 fair value rise and potentially offset a mild decline in profits. More importantly, a sustained easing in inflation trends would likely appease the hawks in the FOMC and incite the Fed to turn dovish sooner than later.

Since 1957, equities performed well after 11 of 13 Fed easing episodes. The R20 P/E was above its 20 fair value in 4 of those episodes.

The Fed signal has been better than Paulsen’s inflation signal in 1957 and 2000 and proved more potent during the last 25 years of subdued inflation.

While on interest rates, David Rosenberg, a bond bull, affirms that “there is no way that we get to any bottom on the stock market absent a slide in Treasury yields (the average decline is -140 basis points).”

That only verifies since 1998 (though not in 2018). Prior bottoms occurred with much smaller declines in Treasury yields, 5 without any and 3 actually after yields rose.

CONCLUSION, P/E ANALYSIS

• The worst case is 2700-2900 if a crisis or stagflation.
• Fair value is in the 3300-3500 range.
• Watch inflation and the Fed, particularly if the economy slows measurably this summer. Slower inflation might bring the doves back and a good buying opportunity along.

PRICE TO BOOK

The S&P 500 index is now selling at 3.7x book value, down from 5.0x at its peak. The pandemic low was at 2.8x, the 2016 low at 2.7x and the 2002 low (mild recession) at 2.4x (the GFC low at 1.6x). Ex-GFC, the low range would be 2400 to 2800.

Using P/B, one always needs to also consider the ROE, the rate of return on book value.

ROE was 12.8% in 2002, 14.5% in 2016 and 15.3% at the pandemic low. There is both a growth and a compositional effect here. At $191 EPS, the ROE would be 19.0% which could justify a P/B in the 3.5x range. Assuming BV declines the “recession usual” 7% to $925, the low would be around 3250.

Another way to look at P/B is its YoY fluctuations over time. Since 1980, the S&P 500 P/B ratio declined an average 19.7% YoY at its lows. The worst drops were in 1982 (-23%), 1988 (-27%), 2003 (-23% at the market low) and 2009 (40.0% with huge financial markdowns). It is now down 21%. Worst case at -40% is 3.0x BV or 3000 but barring a crisis it would decline 27% and take the index to 3375.

(Morningstar/CPMS)

All in all, current fair value falls in the 3300-3500 range. But watch inflation…and the Fed.

May 18, 2021

I realized recently that while the war on inflation from the Volcker era has been thoroughly analysed and explained over the past 30 years, little had ever reached me to explain how inflation was able to creep in to start with, other than with well-known major supply shocks like the OPEC oil embargo of 1973 or the Iranian embargo of 1979.

As it happens, the latest Grant’s Interest Rate Observer started me on the discovery journey of the 1965-1970 period when U.S. inflation sneaked its way from 1% to 6%. See if you find similarities with today.

(…) Until Volcker, inflation had rarely encountered an opponent as determined as William McChesney Martin, the longest-serving Fed chairman (1951–70), who helped to negotiate the accord with the U.S. Treasury that ended the postwar pegging of government bill and bond yields. Martin was all for price discovery in the bond market and price stability at the checkout counter. (…)

Yet the man who hated inflation turned out to be the author of the Great Inflation. That he failed at the work at which he most wanted to succeed—he retired from office as the CPI was running at the shocking year-over-year rate of 6%—is a fact to weigh in the balance of inflationary risks today. (…)

During the 1960’s there was no supply shock and no wage spiral and yet, as the Richmond Fed wrote in 2016

(…) high inflation, so closely associated today with the 1970s, was already ticking upward in the 1960s. While it averaged only 1.5 percent a year from 1952 to 1965, it rose to an annual average of 4.5 percent starting in 1966. In 1969, it hit an 18-year high of 5.75 percent. In retrospect, many scholars now believe that the roots of the 1970s inflationary spiral can be found in the 1960s. The economic historian Allan Meltzer has described 1965 as a turning point on inflation.

But how did it actually happen, how did it evolve from a long, 13 years, noflation period to a creep, then a rise and then a surge? Milton Friedman said that “inflation was always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”. In non-economist words, inflation is essentially caused by demand rising faster than supply. Friedman explained it with a particular focus on the sixties:

To each businessman separately it looks as if he has to raise prices because costs have gone up. But then, we must ask, ‘Why did his costs go up? Why is it that from 1960 to 1964 he didn’t find that he had to pay so much more for labor he had to raise prices, but that suddenly from 1964 to 1969 he did?’ The answer is, because, in the second period, total demand all over was increasing.

President John F. Kennedy, a liberal Democrat, was elected in 1960, a recession year, winning the popular vote against Richard Nixon by 112,827, a rather narrow margin of 0.17%. By the end of 1962, his political fortunes looking bleak with the unemployment rate rising towards 6%, Kennedy decided that only a bold domestic program would provide political momentum in time for the 1964 elections.

Given the stronger economy in 1963, Republicans and conservative Democrats in Congress insisted on a balanced budget. Kennedy disagreed, arguing that “a rising tide lifts all boats” and that strong economic growth would not continue without help from fiscal policy. JFK was convinced that economic stimulation and civil rights legislation would be decisive in 1964.

When Lyndon Johnson became President after Kennedy was assassinated in November 1963, his focus was on his own elections less than one year away. The unpopular Texan, a conservative southern liberal with an acute political sense, was also convinced of the need to continue Kennedy’s drive on economic stimulation and civil rights to have any chance of confirming his presidency.

As Kenneth T. Walsh wrote in the U.S. News & World Report

Few presidents aspired to do more in office than did Lyndon Johnson,” writes political scientist Alvin Felzenberg in The Leaders We Deserved (and a Few We Didn’t). “A man of gargantuan appetites and ambitions, Johnson wanted nothing less than to break the record of his hero, Franklin Delano Roosevelt, who had greatly expanded the role of the federal government in American life. Johnson wanted to pick up where FDR had left off.

LBJ had spent 12 years in the House and another 12 in the Senate where, as majority leader, he became known as the Master of the Senate. He knew all the nuts and bolts, and all the tricks, to swiftly move legislation. Walsh continues:

He immediately set about persuading Congress not only to approve the martyred president’s agenda but to move far beyond the bills Kennedy had in mind. What followed was a huge profusion of legislation to improve social welfare, including the historic Civil Rights Act of 1964 that opened the way for greater equality for African-Americans, federal aid to education, and a large variety of social programs that Johnson called the “War on Poverty.” (…)

Another part of Kennedy’s legacy was even more troublesome—support for South Vietnam in its bitter conflict with the north. Johnson positioned himself as less bellicose than Goldwater in the 1964 campaign, and his relative moderation was appealing to voters. (…)

Johnson won the 1964 election by a landslide. This enabled him to continue expanding what he called his “Great Society” programs as he bulldozed and cajoled a Democratic-controlled Congress into following his lead. Among the vast array of bills that he got passed were health assistance for the elderly and the poor and measures to protect the environment, increase aid to education, prohibit discrimination in housing, and protect consumers.

His “relative moderation” on Vietnam greatly underestimated the Viet Cong’s strength and determination. Unwilling to become the first president to lose a war, he escalated America’s involvement, even hiding to Congress and the American people the true human and monetary costs of the war.

The result was a huge increase in defense spending (red line) adding to LBJ’s Great Society programs. Between mid-1963 to the end of 1966, real GDP grew 6.1% on average, following +4.0% since the end of 1961. Needless to say, this broadly booming demand put a lot of strain on available resources.

When LBJ realized his lifelong dream in November 1964, inflation was 1.3%. It had crept up to 1.7% at the peak of real consumption growth in November 1965 (blue line), but, even after Bill Martin’s Fed hiked rates in December 1965, inflation then took a life of its own reaching 3.8% in October 1966 and went all the way to 6.4% in early 1970.

As the Richmond Fed explains, Johnson’s people

(…) held that the Fed’s primary role was keeping unemployment very low, around a target of 4 percent, and providing stimulus through low interest rates. Unlike Martin, they believed allowing a modest amount of inflation to reach low unemployment was not risky; as long as the economy had not reached full employment, it would have enough slack to keep wage pressures in check. And if inflation did emerge, they believed fiscal policy, rather than the Fed, was the most effective tool to manage it. (…)

Against the Powell Fed telling us that the current inflation spike is transitory and that, in the unlikely event that it were not, the Fed has the tools to intervene, the Richmond Fed offers the lessons of 1965:

Martin strongly believed that the Fed’s core mission was price stability. But he also adhered to the view that the Fed and the other branches of government would work most effectively if they respected the interaction of their policy decisions. As part of this approach, he believed, the Fed had to communicate effectively with Treasury and Congress to achieve a common set of goals. Sometimes this meant that the burden of adjustment (i.e., tightening policy) was on the Fed, since Congress, as the democratically elected branch with the power of the purse, determined the course of fiscal policy, including whether to run deficits. “It is monetary policy that must adapt itself to the hard facts of the budget,” is how Martin put it in a 1965 speech. “Not the other way around.”

Later, Martin was to observe that

Nothing in the background or history of the Federal Reserve Act indicates any misunderstanding by its framers of the laws of supply or demand, or any belief that a Federal Reserve System could control or successfully manipulate, for long, supply and demand forces. Certainly the history of the years I have touched upon tonight demonstrates that you can change the nature of demand and alter the composition of supply, but you can’t abolish the law of supply and demand. That is a law we must reckon with always, for whenever we ignore the working of the market we do so at our peril, and ultimately must pay the piper.

So, unsurprisingly, the Richmond Fed continues,

(…) the rate hike of 1965 did not, in fact, turn a corner on inflation. In the years that followed, fiscal stimulus was ample, war spending kept rising, and the deficit grew. But FOMC members were often divided, and their policy decisions reflected this ambivalence. Furthermore, while Martin saw monetary and fiscal policymakers as obligated to work together to promote price stability and growth, he discovered that dealing with this particular White House and Congress was often a one-way street. (…)

Martin was at odds not only with those officials in the executive branch, but also with some of his fellow FOMC colleagues. The appointments of George Mitchell (1961) and Sherman Maisel (1965) as governors effectively ensured a strong “dovish” plurality. Martin preferred to avoid tipping the scales during votes until he knew where a majority was heading, but as inflationary signs picked up, he increasingly tried to bring the Reserve Bank presidents — who generally were more independent — to his side. (…)

Martin and others on the FOMC soon became alarmed that inflation continued to rise despite the December 1965 hike. It reached 2.8 percent by March 1966, and the effective fed funds rate began to creep over the discount rate, by around a half a percentage point that summer. In July 1966, without the prospect of any action on taxes, the Board asked banks to ration credit rather than raising benchmark rates. This time, the move had broad support.

In the following months, Martin also made progress in another priority: getting high-level support to convince Johnson and Congress to raise taxes to pay for Johnson’s programs. Higher taxes, Martin believed, would relieve the Fed of the need to tighten rates further to offset rising deficit financing. By fall 1966, both Ackley [chairman of the Council of Economic Advisers] and Fowler [Treasury Secretary] began siding with Martin on this point, even though both were unhappy about the December rate hike. Still, Johnson continued to resist. Powerful fiscal conservatives in Congress wanted domestic spending cuts in return if they were going to raise taxes — and that was a bargain Johnson refused to consider.

The summer tightening of 1966 did dampen inflation temporarily but brought with it the side effect of a deep credit crunch. By spring 1967, Martin felt that inflation had slowed down enough to allow the Fed to dial the discount rate back to 4 percent — on the condition that Johnson would finally push his tax hike proposal in Congress. Again, the president resisted.

It was not until spring 1968, when the Johnson administration and the Fed had to scramble to address a balance-of-payments crisis caused by destabilization in the gold market and a looming collapse of the British pound, that Johnson and Congress found the support to move the tax hike package. (It was also at this point that Johnson had decided against running for re-election.) But by then both interest rates and inflation were moving higher. In fact, starting in fall 1967, the Board had begun raising the discount rate again, and by July 1969 it reached 6 percent; the effective fed funds rate topped 10 percent.

What were the drivers of this inflation? To be sure, Johnson’s policies produced a sharp rise in deficit spending, which Johnson failed to offset with higher taxes until the waning days of his presidency. From 1965 to 1968, the deficit jumped from 0.2 percent of gross domestic product to 2.7 percent. But the inflation of the 1960s also can be traced to the expansion of the money supply. From the mid-to-late 1960s, it grew at an annualized rate of 5 percent to 7 percent, well above the average of 4 percent in the first half of the decade. (…)

The persistence of inflation weighed heavily on Martin in his final days as chair — so much so that at his lavish farewell party at the White House, he shrugged off a series of laudatory toasts. Instead, he offered an apology for the state of the economy. “I wish I could turn the bank over to Arthur Burns as I would have liked,” he said. “But we are in very deep trouble. We are in the wildest inflation since the Civil War.” He then sat down, to uneasy applause.

Milton Friedman also used the famous “transitory” word but in a rather different transition process:

The only cure for inflation is to reduce the rate at which total spending is growing. There is no way of slowing down inflation that will not involve a transitory increase in unemployment, and a transitory reduction in the rate of growth of output. But these costs will be far less than the costs that will be incurred by permitting the disease of inflation to rage unchecked.

It will be interesting to compare the future sequence of events with that of the sixties.

We know that Democrats will totally focus on maximizing their odds for 2022 and 2024.

The unknown, however, is the how the Fed’s recently modified interpretation of its dual mandate will affect its future policy. At the end of August 2020, the Fed released an updated statement to the Longer-Run Goals and Monetary Policy Strategy published in 2012 and reviewed in 2019. The Brookings Institute:

The statement gives Congress, the public, and the financial markets a sense of how the FOMC currently interprets its congressional mandate—to aim for maximum employment and price stability—and the framework it will use to make decisions on short-term interest rates and other monetary policy tools. To compare the old and new Fed statements of long-term goals, see this guide. Going forward, the Fed plans to conduct a review of the statement every five years.

The new statement introduces the apt moniker FAIT, Flexible Average Inflation Targeting, giving the FOMC the flexibility to let inflation rise above 2% for an undefined period after a period of below 2% inflation.

On unemployment, Jerome Powell said (my emphasis):

The old statement said the Fed would adjust policy based on “deviations from its maximum level.” The new one says the Fed will base its decisions on “assessments of the shortfalls of employment from its maximum level. The change in wording may appear subtle, but it reflects our view that a robust job market can be sustained without causing an outbreak [undefined] of inflation.

To the Economic Club of New York on February 10, 2021, Powell provided additional precisions:

The revised statement emphasizes that maximum employment is a broad and inclusive goal. This change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities. Recognizing the economy’s ability to sustain a robust job market without causing an unwanted increase in inflation, the statement says that our policy decisions will be informed by our “assessments of the shortfalls of employment from its maximum level” rather than by “deviations from its maximum level.” This means that we will not tighten monetary policy solely in response to a strong labor market.

This Fed has given itself much flexibility: flexible on inflation and flexible on its “assessments of the shortfalls of employment from its maximum level” and its effects on minorities.

We will all have to adjust to the Fed’s subtleties as Powell explained at at National Community Reinvestment Coalition event on May 2, 2021:

Powell noted that the Fed’s central mandate is to ensure a strong economy that would lift everyone, but pointed to fiscal and monetary tools that could ensure a more targeted response, such as strong supervision of racial equality laws and efforts to focus on community financial institutions that serve minority populations.

Allowing deep-rooted inequalities to persist, he said, would have implications for the wider economy.

“The Fed is focused on these long-standing disparities because they weigh on the productive capacity of our economy,” he said.

“We will only reach our full potential when everyone can contribute to, and share in, the benefits of prosperity.”

If Janet Yellen moved from the Fed chair to Treasury Secretary, one could say that Jerome Powell has set a foot in each job. Such dynamic duo of very similarly noble minds is likely to test the historical and necessary independence of the Federal Reserve. But rest assured, Powell wrote to Senator Rick Scott on April 8, 2021

We understand well the lessons of the high inflation experience in the 1960s and 1970s, and the burdens that experience created for all Americans. We do not anticipate inflation pressures of that type, but we have the tools to address such pressures if they do arise.

Interest rates being where they are, Powell must know he will need teamwork if “we” need to “address such pressures if they do arise”. But he may be underappreciating the importance of 2022 and 2024 in the Democrat politicians’ agenda.

As William McChesney Martin learned, “you can’t abolish the law of supply and demand. That is a law we must reckon with always, for whenever we ignore the working of the market we do so at our peril, and ultimately must pay the piper.”