Bullish Inflation Forecast Supports Our 8,000 S&P Target

We are very bullish about inflation declining to the arbitrary 2% target this year as the massively delayed shelter component of inflation finally reflects market rates and we roll off very high PCE prints in January and February of 2025.  We forecast that PCE core inflation with roll down to 2.4% after the first quarter of 2026 and decline to 2% by the end of the year as shelter inflation rolls down throughout the year.  Money supply growth is down over 6% year over year, and oil prices are down over 20% on the year.  The roll down in inflation will support 3 Fed rate cuts in 2026 and drive the 10-year to 3.75% by the end of the year.  Lower rates will support our 23x target on 2027 S&P 500 index earnings resulting in an 8,000 target on the S&P.

Federal Reserve members and market participants have expressed concerns that inflation could re-accelerate due to tariffs and the potential for inflationary expectations to become “unanchored”. These concerns are completely unfounded as inflation is exclusively caused by excessive money supply growth and not significantly influenced by inflationary expectations at all.  In fact, inflationary expectations are actually deflationary as rising inflation expectations cause long term bond yields to rise and restrict the flow of capital to the crucial residential sector. The concept that inflation can feed on itself has no relevance to the modern economy as market participants currently have no market power as unionization has plummeted, so workers are price takers not price makers.  Consequently, their inflationary expectations have no market impact.  Keynesian economists continue to cling to the discredited “expectations” theory of inflation as their Phillips Curve models blew up during the Pandemic, and they have failed to revise their models.  ECB research and many recent academic studies have rejected the expectations theory of inflation as a significant guidepost for the formulation of monetary policy.

Almost all current and former Fed members continue to defend the Fed’s arbitrary 2% inflation target that was adopted without any empirical analysis to support it.  Their rationale is the discredited “expectations” theory of inflation which irrationally assumes a more flexible range of 2-3% will lead to inflationary expectations becoming “unanchored”.  The implicit adoption of the 2% target in the 2000’s led to the Fed raising rates 17 meetings in a row despite inflation never significantly exceeding 2%, which precipitated the Great Financial Crisis.  Fed tightening has precipitated all 13 post WWII recessions.  The Fed’s arbitrary 2% target is clearly too low as post WWII inflation has averaged only 3.1% percent with inflation only being a significant problem during the 70s and 80s (inflation averaged 5.5% with money supply growth averaging 6.3%), and during the great inflation of 2021 where the Fed increased the money supply by 60% over a 2 year period.  Inflation during the 70s and 80s period was also exacerbated by an explosion in oil prices due to Middle East wars and wage and price controls on US oil production, both of which are unlikely to reoccur.  Finally, a precise inflation target is inappropriate as CPI/PCE is mis-measured with at least a 2-year lag between market inflation and measured inflation which argues for a more flexible target of 2-3%.  Finally, monetary policy acts with a lag, so overly precise inflation targets are highly inappropriate. 

Kevin Warsh continues to aggressively defend the Fed’s dangerously low 2% target.  We believe that he would be a disastrous choice for Fed Chair as his hawkish stance will almost certainly lead to an unnecessary recession in the future, as occurred in the late 2000s as the Fed’s ultra hawkish policy melted down the global financial system.  Warsh would be a far worse mistake than Trump nominating Powell, as Powell was neither hawkish nor dovish but was simply an unqualified attorney who did not recognize that the money supply mattered to inflation so was completely unable to forecast inflation.  This incompetence led to the “transitory” theory of inflation and precipitated the Great Inflation of 2021.

The sole driver of inflation is excessive money supply growth.  As Milton Friedman stated, “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output".  Friedman’s theory was proven to be 100% correct as the Fed’s excessive monetary stimulus during the Pandemic was similar to a controlled experiment to test the quantity theory of money and it 100% proved Friedman’s theory as the money supply grew 60% during the Pandemic, nominal GDP grew at 38% and inflation over the period was 22%.  Inflation has historically has only been caused by excessive monetary growth and does not spontaneously ignite.  Since WWII, we have never had inflation significantly exceed 3% without the money supply increasing by more than 6% annually.   The Fed should be far more focused on its employment mandate and recognize the fact that inflation has never spontaneously accelerated without excessive money supply growth.