Why the Fed’s war on inflation could lead to bargains for investors
On Friday at Jackson Hole in the U.S., Federal Reserve Chairman, Jerome Powell, spoke for eight minutes and 38 seconds reinforcing the idea that restrictive monetary policy is likely to be maintained for some time – all in the name of fighting inflation. World markets quickly went into reverse. The good news is that savvy investors may now get another chance to buy quality businesses at attractive prices.
In his address, Chairman Powell also said:
“Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.”
Over the last month we have warned investors about the dangers of extrapolating peak inflation. Here at the blog, on radio, TV and in The Australian, we’ve explained while peak inflation may have indeed passed, it is a mistake to believe, as equity investors appear to have, inflation will rapidly decline to the U.S. Federal Reserve’s inflation target of two per cent. We concluded, therefore, a typically impatient stock market could be disappointed in the failure of the U.S. central bank to meet investor expectations for rate cuts next year.
For those investors we warned might be premature in their expectations of rate cuts next year, the Fed chair added not to expect the Fed to dial back quickly until the inflation genie is back in the bottle.
Powell again: “We must keep at it until the job is done. History shows that the employment costs of bringing down inflation are likely to increase with delay.”
And just as I wrote here at the blog on August 17, 2022, citing the strong US employment market, “that inflation could prove to be more persistent than the market currently hopes” and “investors may yet see another reversal in prices”, Jerome Powell’s speech cited “strong underlying momentum”, a job market “clearly out of balance” with job openings far in excess of the level of unemployed.
Powell’s speech offers several takeaways for investors.
First, it is the U.S. central bank’s primary job to concentrate its resources on achieving and maintaining low inflation. This is of paramount importance lest inflation begins creeping into expectations. Higher inflation expectations would bring forward purchases, itself creating inflation, whilst also being built into wages expectations.
Second, the Fed’s resolve to contain inflation at all costs is undiminished.
Third, investors should not expect a sudden dovish pivot, as they’ve done recently, and instead should factor in higher rates for longer.
And finally, higher unemployment will be acceptable to the Fed in order to deal with the demand side’s contribution to inflation.
Investors who have followed our columns and articles about taking advantage of compressed price-to-earnings ratios, may now be offered another opportunity to purchase high quality companies at rational and even attractive prices.