Quantitative teasing has been the Fed policy for the last eighteen months as real measures of inflation took hold, but were met by the verbal Fed tool calling it “transitory”. Covid is also transitory, but that did not mean it should be ignored. White House commentary followed this same line for months as if the problem would disappear like a northeast breeze. Unfortunately, all the dithering has compounded the inflation problem in a few ways; 1) the lack of early sizeable increases in the Fed rate has set off several cycles of price increases that will not be reversed by rate increases; 2) the delay of the rate increases now has them coinciding with the Fed shrinking its balance sheet which will exacerbate the slowing of the economy; and 3) the Fed is now forced into a strategy of “catch up” rather than quashing inflation by leading. White House sensibilities about being held politically responsible for inflation only served to muddy the leadership on action. It is reminiscent of the late 1970’s when the Carter administration was uncomfortable with Alfred Kahn, Chairman of the Council on Price Stability, and chided him for using the word depression. As a counter, Kahn substituted the world banana, often saying “the economy was headed into a banana.”
The early 1980’s inflation fostered an era of regular double digit wage increases, steep mortgage rates, strange changes in accounting rules, such as “replacement cost accounting”, interest rate hedges and the world of floating rate loans where borrowing costs were no longer predictable. The Fed will now take a few years trying to put the genie back in the bottle while trying to stave off a recession. What does this environment imply for private equity investors? Purchasing companies that have demonstrative pricing power will be a key strategy for offsetting rising costs of labor, capital and commodity inputs. Due to the increased sporadic nature of supply reliability, multiple sources of supply across the globe will become increasingly important as one looks to manage risk.
I’m Rob Morris and I approved this blog.