I would like to take you back to 2012. Just a few short years after the soul-searching-scary Great Financial Crisis of 2008-9, market participants had finally given up their worry of the next great depression enveloping the globe, but had replaced it with an equally fervent fear that inflation would uncontrollably explode.
The Federal Reserve had recently completed their second round of quantitative easing, much to the chagrin of a large group of distinguished economic thinkers who had gone as far as writing an open letter to the Fed Chairman pleading he reconsider the program.
You remember that old A&E show Intervention? Well, this was like an academic peer episode - more neck beards and sophisticated language, but sadly, the same amount of crying.
So when the Fed’s favourite inflation gauge, the Core PCE index, spiked up to 2% in 2012, it was especially hard on Chairmen Bernanke. After all, his colleagues had just warned him that this was about to happen.
Like any good addict, Bernanke insisted he had his usage under control.
In fact, during a 60 minutes TV interview, when faced with the question about how confident he was that he could control inflation, he responded - “100%.”
Yet, here was Bernanke, staring down the barrel of 2% inflation, having done nothing to prepare the market for higher rates. He believed the inflation was “transitory” and it would be a mistake to nip off the budding recovery with tighter monetary policy.
The hawks went ape-shit. They screamed and yelled. They warned about Weimar Republic style hyper-inflation. But Bernanke hung tough.
This was bold. It took guts.
Now you might think it was wrong - so be it. I am not so omniscient to give judgment, but more importantly, it’s in the past, so arguing is about as interesting as when your 98-year-old grandma tells you that she was once “quite a dish.” Yeah sure, it might be true - but it ain’t doing anything for anyone today.
I am more interested in what this might mean for markets going forward.
This episode provided an important “lesson” for markets. I think that Cullen Roche’s admission was symbolic of the change of thinking that went through financial circles - The “Transitory” Inflation… Bernanke was right.
I don’t often give Ben Bernanke a lot of credit for the job he’s done. I am admittedly hard on him and perhaps unfairly so. But he deserves some serious credit for his persistent comments on inflation in the last 24 months. Dr. Bernanke was mercilessly mocked in some circles for calling the surging commodity prices following QE2 “transitory”. In early 2011 he was cited:
“I think my take on inflation right now is that we are indeed seeing some increases, obviously,” Bernanke said. He attributed them to “global supply and demand conditions.” But he reckons these prices “will eventually stabilize.”
“I think the increase in inflation will be transitory,” Bernanke said. But we added: “we have to monitor inflation and inflation expectations extremely closely because if my assumptions prove not to be correct than we would certainly have to respond to that.”
He was further mocked by some who said the inflation would prove global in nature and that the impact would eventually spread to the USA. But this excellent chart below from Also Sprach Analyst shows that Ben Bernanke was very right about inflation. He deserves a great deal of credit for his prescience on the inflation front.
Although I believe the next surprise will be disappointing global economic growth, and not the other way round, I come from the Yogi Berra school of forecasting - “it’s tough to make predictions, especially about the future”, so I fully accept the possibility that inflation might take off in the coming quarters.
But I want to highlight that the stage has already been set for the Federal Reserve to “look through” those increases. Don’t expect Core PCE ticking above 2% to alter the Federal Reserve’s course. After all, I am sure that Bernanke has passed down the secret recipe for being able to 100% control inflation to Powell. No need to worry. Trust him, he just uses it recreationally.