“The single biggest problem in communication is the illusion that it has taken place”. – George Bernard Shaw

Dear Clients and Friends,


In the Fall of 1983, the US and its European allies conducted a war-games exercise called “Able Archer”* that culminated in a DEFCOM 1 coordinated nuclear attack against the USSR.   This event was arguably the closest the world had been to full scale nuclear war since the Cuban Missile Crises, and we now know this after documents declassified over the last decade revealed that the Soviet Military was on high alert throughout the exercise. A Soviet double agent working in the UK, Oleg Gordievsky, was able to assuage the tension by covertly conveying information that deescalated the standoff.  He did this by feeding information to the British that the Soviets were genuinely fearful of a preemptive nuclear strike, while letting the Soviet leadership know that the West did not want Nuclear conflict. Today, the Federal Reserve, and Jay Powell in particular, are playing the role of double agents with our markets: feeding information to both sides of the market while trying to avoid a potential conflict. We will see if it works.


We are all fearful of a recession; this is simply a universal fear among all investors. The Federal Reserve is no different. Jay Powell doesn’t want to see the economy crater under self-inflicted interest rate hikes. No one in 1983 wanted to see a Nuclear Holocaust, but neither side wanted to be the ones caught flat-footed in the event of a preemptive attack. KGB double agent Gordievsky had a rare position in the potential Nuclear Standoff; he realized that his power of espionage would help avert the potential crises. He opened the lines of communication by explained to the British that Gorbachev was someone who the West could trust and work with.  Some argue that this was a breakthrough for the West and allowed a framework for de-escalation.  The Federal Reserve is finding out that they are walking a similar tight-rope. The Fed wants consumer demand and government spending to slow in light of higher rates, but they don’t want the market to crater – in turn they are hoping this provides a glidepath to lower inflation without harming employment.


A few months ago, I wrote that consumer debt would be a problem at some point in the next 12 months. Since then, the consumer hasn’t slowed spending. Mortgage rates hit 8% a few weeks ago, and this only adds to the pressure within the real estate market. Student debt repayments are now in full swing, putting additional pressure on the consumer, and should begin to show deleterious effects by the end of this year. The market has posted poor performance for the last few months, with most stocks in the market losing money for the year. And yet, the market rallied last week after the Federal Reserve decided not to raise rates. Has the market already moved past the coming slowdown? The soviets saw the military exercise as a threat and the Allies viewed it as ‘business as usual’.  The Fed sees interest rate hikes as business as usual, but the manic depressive market has viewed them differently over the last few years.  I think the Federal Reserve has a lot to consider in the coming months as the new data reveals the consumers mood and appetite for spending.


As with all things in the future, Mark Twain puts it best: “it’s not what you don’t know, but what you know for sure that just ain’t so”. The job of avoiding bad outcomes is no simple task. Whether it is foreign policy, war, or our markets…some of the smartest minds get it wrong. But if this lesson in spy craft can teach us something about avoiding bad outcomes, it is this – communication is key. The Federal Reserve is communicating with our markets, with the consumer, and with the US government, but are they listening? The consumer and government will have to tighten the belt in the coming 12 months, and the markets will have to respond to the outcome. My hope is that we see the economy slow gradually and inflation hit the 2% target, but I am very receptive to a less sanguine outcome.


* https://en.wikipedia.org/wiki/Able_Archer_83

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