[TOP STORY] US interest-rate decision expected from the FOMC later today

Slower economic growth or economic contraction requires a different investment stance, points out Adrian Saville of Genera Capital.

SIMON BROWN: I’m chatting now with Dr Adrian Saville of Genera Capital. Adrian, I appreciate the early morning time. Interest rates in the US – a decision [is expected] from the FOMC [Federal Open Market Committee] later today. I was pondering back and I remember when the dot plots came out last June and suddenly interest rate [increases] were looking to happen in 2023. Then they were this year; they were at 25 [basis] points. Then it was 50 points in the last meeting. Now talk today is about maybe 75 points. Is it not time for the Fed? We have talked about how far behind the curve they are to almost do a Paul Volcker (former US Fed chair) do a full 1% and, and really aggressively tackle the inflation?

ADRIAN SAVILLE: I remember our conversation – forgive me for not having the exact date – perhaps seven, eight months back, where we were talking about the origins of inflation and whether it could truly be as entrenched as it appears.

Listen/read: How important are inflation expectations?

That seems to be coming to pass. There are some forecasts or predictions you don’t want to come right, and sadly the one that you don’t want to come right is the one that comes right.

So here we are with very elevated inflation that looks like it’s set to stay. Why would a Volcker moment be needed where the Fed steps [in] and essentially shocks Wall Street and Main Street into the reality that the inflation is entrenched? Why is that needed?

I think it’s because inflation has moved from being a monetary phenomenon to a phenomenon of the mind – that it’s moving into the psyche.

That’s where you start to get expectations and wage negotiations and agreements based on ‘I believe that this inflation is here to stay and it’s nonsense to negotiate on 2%; I’m negotiating on 8%’.

SIMON BROWN: It does become – we’ve spoken around that – expectation in it. Part of the reason why the Fed has been treading more carefully is they’re trying to negotiate a soft landing, I would imagine. Is a soft landing almost off the table? Either we get a soft landing and we keep that inflation, which is not desirable, or we sort of start to tame inflation but we probably get a hard landing.

ADRIAN SAVILLE: Yes. It’s like poking a bit of fun at our inability to forecast. Here’s a forecast that I’d like to get right – that we are in for a soft landing. The odds are stacked against my wish and the Fed’s ambition because,

…if you take the last 70 years, there is no time when the Fed has been able to get inflation from above 5% to below 5% without a recession following. There’s no instance when that has been done. So if we take that as the default, then the question really becomes how deep and how long the recession is, rather than will there be a recession.

And even if there isn’t a recession, perhaps we can just pull a little bit away from the obsession with ‘negative equals recession’ and just recognise that, whether it’s negative or very, very low, the near future is going to be a period of much, much slower economic growth or perhaps economic contraction than we’ve been used to, and that requires a different investment stance.

SIMON BROWN: That’s a great point. Recession’s a technical term; it’s going to be tough with or without it, and that really matters. I was just trying to dig through – and I’m having to do this manually because I don’t have the raw data – it looks like the last time the Fed did an increase of more than half a percent was 1994, which was in the days of Bill Clinton. I don’t remember ’94 being that bad, but obviously then the Fed Reserve did.

A last question, Adrian. There’s one thing that I’ve been pondering. Let’s say that the rates in the Fed, in the US, are going higher, whether he [US Fed chair Jerome Powell] goes massively aggressive or not, the point is they’re moving higher for the first time in decades. We’re going to see this in the Treasury bills. It suddenly occurred to me, if you can suddenly start getting 6%, maybe 7% or 8% – I know this sounds crazy – in the US, in a Treasury bill, that’s bad news for us, because suddenly no one wants to buy our bonds. So our bonds get more expensive and our rand goes weaker at the same time, as everyone rushes off to buy American debt.

ADRIAN SAVILLE: We saw that on Friday afternoon, where the rand responded quite vigorously to the shock news of the higher-than-expected inflation in the US, when they printed 8.6%. That means US rates are likely to go up 75 basis points, not 50, and that makes the rand, all else equal, a little less attractive. The rand moved from I think it was R15.30/dollar territory to R15.90/dollar, and is now above R16/dollar on the back of that news. We’re a long way off still from the Fed being in 6% or 7% territory. That said, the Taylor Rule wants US interest rates at 6% or 7%. And a third ‘however’ in that statement is, if you look at the forwards on inflation predictions, the data says that the US is going to be able to get sub-5% without getting interest rates all the way up there. So it might not be as dramatic as a 6% or 7% yield in the US, but it’s going in that direction. My strong suspicion is we get 75 [basis points] of that hike later today.

SIMON BROWN: Yeah. I think it’s 75. I think he should do 1%, but I’m not the one who earns the big bucks here. So we’ll stick with the 75.

Dr Adrian Saville of Genera Capital, I always appreciate your insights. Thank you.

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