Interesting view of what is going on with inflation

Quote from Greg Foss: 

"Over the last couple of weeks, The Bank of Canada (BoC) and the Federal Reserve have told us that we can expect additional rate increases this year. I have some thoughts about this that I wanted to share. I have them below. Before I jump into it, some quick updates on fixed rates first in case you want to move on with your life lol.

5yr fixed rates are starting creep up. The best rates we can offer are currently in the 5.00% range for less than 20% down and 5.50%-5.80% for over 20% and rentals. Below is a chart of the 5yr bond yield that fixed rates are priced at. In the top chart you can see the increase over the last 30 days of approximately 15%. In the second chart, you can see we are currently at the same rate as 2007. 

 Learning from the Past

The Fed and the BoC have increased rates aggressively (450% in 12 months) and what has happened so far? Nothing. No recession and inflation is stuck. People are buying homes like crazy. If there were 300 more homes for sale in Cochrane, or in Canmore, or Airdrie, would it even matter? I feel like they would be sold very quickly. If there were 1000-2000 additional homes for sale in Calgary, I feel like it would be the same thing. That leads me to believe that the demand is there, even if there are high interest rates. A nearly 500% increase in rates and no slow down in housing. Theories abound as to why. Lack of inventory. Population increases. Fear of higher rates. etc etc.

 In the 70's, 2 Federal Reserve presidents were fired because they did not fix inflation. It crept up after rates were paused. The 3rd president that fixed the problem was Paul Volker. The previous 2 presidents tried raising rates and pausing and raising rates and pausing without touching liquidity. Inflation stayed the same or increased. Paul Volker took the liquidity out of the Market and let interest rates run freely. That led to very high rates and no liquidity. Bye bye inflation. 

 At this moment in time, the Fed and the Bank of Canada are making the same mistakes in my opinion. That mistake has nothing to do with rates, it has everything to do with the extra cash/liquidity that is in the market. Long story short, The Fed and the BoC can take that liquidity/extra cash out of the market just as easily as they put it in there. 

Liquidity

The Fed has the power to withdraw TRILLIONS of dollars out of the system. Look at the 3rd chart below. You can see the growth of the Fed balance sheet since 2007. This means they created money and put it into the system to be lent out or invested. I thought this was interesting. Look at 2008. It's a little blip. Remember when that happened and it was the end of the world that they spent 700 Billion to save the financial system. To put it in perspective, they spent 400 billion in March alone to help out a few banks. 2008 is nothing compared to what has been spent during COVID. Look at the Fed balance sheet chart again. Back to 2008, did you notice that the balance sheet increased and has not decreased. Slightly decreasing in 2018 (and the stock market took a 20% dip in 45 days when that happened). This means that the Fed was/is artificially keeping rates low and pumping money into the system. In order to make inflation look low, the White House manipulated numbers. Housing doesn't need to be included!  

 This chart makes me question, will they keep pushing rates higher and not aggressively reduce liquidity? Probably. So that begs the question, how high are they willing to push rates? The higher the Fed pushes rates, the stronger the US dollar becomes. When that happens the rest of the Central banks around the world are forced to increase their rates so that their currency does not loose too much value compared to the US. This should be interesting to watch. The UK financial system almost broke when they rates were at this point in Sept 2022. AS of today, rates are now higher. Pensions were not being paid and people realized that they system could not handle high US rates and a back door deal was made to fix it. How did they fix it? More liquidity! The Fed transferred the UK a few hundred Billion to smooth things over. 

Inflation is high, so they raise rates. High rates start to break things, so they put a band aid called liquidity over it. And inflation stays the same or goes higher. They start to withdraw liquidity, big things fail/break, like entire countries. So, they pump more liquidity. Inflation stays the same. Then what? 

 In Canada we are affected by the Fed's decisions to raise or lower rates. Our inflation may start to come down, but can we devalue the Canadian dollar too much if the US rates stay elevated and we lower rates. Time will tell.

In the mean time, over the next 6 months, expect the Bank of Canada to raise rates along with the Fed. This will increase fixed rates with it. "

I agree with Greg, but I would like to add that the FED definitely has the option to withdraw the stimulus and stop raising interest rates. However, we all know what the result would be:  the stock market would crash!  All politicians from all parties around the globe made a choice to play interest rate charade in order to stay in power. Because if they withdraw Q Easing and turn into Q Tightening, they will be voted out.