Inflation = Too much money supply available for too few goods

As we entered the days of a pandemic our supply of goods came to a screeching halt as the world shut down manufacturing. The Federal Reserve (“FED”) stepped in with Quantitative Easing (“QE”) by buying US Treasury and Mortgage bonds while keeping interest rates at historically low levels.

What is QE? Think about the car movie, The Fast and Furious, and the effect that nitrous oxide had on speed and performance – off to the races! The FED may have gotten out ahead of their skis a bit when they bought $987 Billion in Treasury Bonds and $567 Billion in Mortgage Bonds during 2021. In turn, that poured gas on the consumer spending fire, which eventually put upward pressure on the price of goods and services, AKA inflation.

In addition, the US Treasury Department, by way of the Internal Revenue Service, further stimulated the economy with three stimulus checks. This tells the tale of where the massive money supply came from.

How does the FED slow the train down? Quantitative Tightening (“QT”) is the Hydeto QE’s Jekyll. As the notion of transient ”inflation became knowingly false, The FED had no choice but to begin pulling their monetary policy levers in an aggressive manner. Not only did they stop buying bonds, but they also began letting their purchased bonds come to maturity without replacing them. Simultaneously, they ratcheted up their short-term interest rates by 4% in 2022. Incredible disruption ensued!

As QT took hold of the mortgage bond market, the servicing value of mortgage bonds was stripped away due to fear of future refinances away from the higher rates of 2022. The simple answer: liquidity dried upand the FED is not interested in stepping in to goose the market (QE) because of the inflation concerns. The market has now been fishing in thispond for close to a year. Once we plateau, stabilize,and begin to come back down, adrop in interest rates may be accelerated due to the renewed demand from servicers-an increase of liquidity moment.

There will be headwinds over the coming months,but the light is beginning to flicker at the end of the tunnel. There are signs of a tight labor market andinflation is beginning to creep down.The idea of a “soft landing” versus full recession will likely be the source from which that flicker shines. Stay tuned…