Historically, rising inflation has always produced an increase in interest rates. Investors demanded higher rates to keep up with inflation, and bond prices dropped (yields rose) commensurately.
The Fed has had to cope with this precept ever since its inception.The correlation between the two has been as immutable as, say, COVID-19 and 2020 indoor weddings.
Just as vaccines have changed the wedding landscape, the Fed’s unprecedented expansion of QE has made high inflation survivable. By essentially buying up the entirety of the Treasury’s issuance, the Fed has broken the link between interest rates and inflation.
Markets have thus been trained to ignore the inflationary risks [what’s the big deal?] and push on to new highs seemingly every day. Consumers, particularly those who have no investable assets, aren’t so lucky. They are struggling with the rising rent, food, gas prices, etc. which the Fed’s actions have produced – a fact which many Fed presidents (but not its Chair) have acknowledged.
Stimulus payments and an eviction moratorium provided consumers a modicum of immunity, but those protections have been discontinued. The next few months will be quite different for the have-nots. Will the effects be contagious? Will breakthrough infections spread through the broader economy?
You can put a COVID patient suffering from respiratory failure in an ice bath and bring down their fever, but they’re still very sick. Likewise, central banks can produce the appearance of a healthy economy by forcing interest rates/volatility lower and stocks higher, but they’re only treating the symptoms. Stagflation remains a very serious concern.
Stay tuned.
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