What a difference a year makes.
The markets were quietly making new highs in February 2020. Economic growth was slow and steady with GDP close to 2 percent, and inflation largely nonexistent.
Then Covid arrived, disrupting economies around the world and ushering in some of the biggest changes to how we live and work in our lifetimes.
Looking at the events that unfolded, and the government and Federal Reserve Bank's response to them, is still jaw-dropping.
The decision to shut down the economy in the wake of the unknown threw it into immediate recession. The Dow and S&P dropped over 20 percent is three weeks. The bond market, the plumbing of all the markets and the economy, essentially froze.
It was not just any recession. It was actually five times the average of recessions since World War II. It also happened in just a quarter of the time. Eleven million people lost their jobs, the biggest percentage drop since the Great Depression.
The government was quick to respond with the Cares Act, including direct payments, loans, and rent and mortgage payment forbearance. In three months, these trillions of dollars increased the deficit by more than the past five recessions combined. So much was distributed that even with the job losses, net income increased by the largest amount in 20 years.
That was the fiscal side. On the monetary side, the Fed immediately slashed interest to zero, and then started buying bonds on a massive scale to get both the bond market functioning again and to bring longer term rates lower. In six weeks, the Fed bought more bonds than it had in the previous 10 years.
Corporations, rather than reduce debt to shore up their balance sheets as they had in previous recessions, took advantage of the Fed's largesse and issued $400 billion in new debt. By way of comparison, they reduced it by $500 billion during the last crisis.
But it had the desired effect, for Wall Street anyway, and the massive stimulus drove the market, led by technology shares and online shopping, to new heights. Who could have predicted how well the economy would fare in the wake of the shutdown? Imagine if this had happened 10 years ago, or even 5. From an infrastructure standpoint, we were prepared for this and didn't know it.
All this stimulus does come at a cost. On the chart below, the blue line shows how the money supply has exploded since the pandemic started. In fact, it is up 20 percent in just under a year. When asked on 60 Minutes where all the money to pay for everything was coming from, Chairman Powell famously deadpanned, "We print it, digitally." Creating money to spur growth was the easy part. Ratcheting it back now that things are stabilizing may prove more difficult.
The purple line is the velocity of money--how fast it moves around the economy. If people put money in the bank, it slows, and if they spend it it speeds up. The velocity has been dropping precipitously for obvious reasons, but as the economy opens up money will start to get spent. On top of that, we are getting the long-awaited stimulus package that could put up to another $2 trillion in spending power out there. While all this liquidity is great for Main Street, it is starting to get the bond market spooked.
Higher inflation rates lead to higher interest rates. Interest rates were steadily moving higher as the economy improved, but recently have started to accelerate higher at a faster pace.
The Fed has explicitly said that it wants to see inflation rise for a sustained length of time as a sign of a growing economy. However, too much at once could lead to an interest rate spike. Low rates have underpinned both stocks and real estate, the two biggest bright spots since the whole pandemic started. All eyes are on the Fed as it navigates its way through this.