According to a survey of large endowment and foundation CIO’s conducted by KKR that was published this week, 57% of the CIO’s put inflation as their number one concern. However, less than a quarter of the CIO’s believe the Ten-year will be over 3.5% in 2023 and more than half of those polled believe that the Ten-year will be below 3% next year. Mind you, the Ten-year traded as high as 4% mid-week. Given everything we see and read about bearish positioning, this survey strikes me as optimistic. These are CIO’s with many billions of dollars of AUM who clearly do not embrace the reality that the days of historically low interest rates are behind us.

So what does it imply about the thinking of these CIO’s that more than half of them believe the Ten-year will be sharply lower next year? My interpretation is that the majority of elite level market participants still believe that the Fed is going to do its job and crush inflation at which point we can all go back to enjoying the good old days of disinflationary growth. In other words, sentiment remains that it isn’t different this time and the playbook of the last four decades is still the hymnal from which to sing. I disagree. I do agree that the Fed will ultimately bring down inflation via an economic recession. But my longer-term view is that as soon as the US economy begins to come out of the recession, the inflationary pressure will again be the main concern weighing on financial markets. While this bout of global inflationary pressures may have begun with fiscal and monetary authorities printing too much money and stoking too much demand, the issue now is supply constraints and those supply constraints are largely secular.

To be clear, our near-term consensus aligned view is that growth is slowing rapidly toward a US and global recession and like every previous recession, measures of inflation will fall and might even fall precipitously. Our more important view though, and one that the survey suggests remains a contrarian call, is that we face a future of structural inflation that will pressure long-term interest rates higher.

I also suspect that while it is necessary and easy for Fed officials to talk bravely talk about holding the line and continuing to raise interest rates amid job losses, they have yet to enter the arena, stand in the glaring sun and stare down the charging bull. By the end of this year, it will be clear to everyone that housing prices are going to be down nationally, layoff announcements will crowd the headlines and we will have seen CPI prints that make it clear the economy is shrinking and inflation is falling. I’m not calling for a near-term “Pivot”, but I do think we will hear Fed speakers warning that monetary policy manifests with long and variable lags and you will see the dots on the dot plot start to come down amid economic weakness. While that will be bullish for the front end of the curve, it will be less bullish for the long-end as there will be the inflation hawks who argue that Powell et al have failed to prove their Volcker-like resolve.

Every day I read about or see a pundit lamenting the risk of a Fed policy mistake. The concern is that the Fed isn’t respecting the lag in the policy actions already taken and they end up crashing the economy unnecessarily. What that suggests to me is that Wall Street’s economists and strategists are still looking at the inflation problem from a cyclical excess demand lens when the real issue is a secular lack of supply.

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