With economists wondering what the next six months holds for the global economy – and private equity mangers carefully watching what the forecasts are – three charts are on the mind of every private equity manager right now. Here’s a look, and what they might mean for the private equity outlook.
Inflation
The hidden tax – inflation is running at an 8.2% clip (year-over-year), down slightly from its recent March high of 8.6% (CPI, All Urban Consumers). The inflation rates, the highest we’ve seen since 1982, poses a challenge for the workers around the globe trying to keep up with a standard of living they enjoyed just a few years ago.
Interestingly, public and private markets typically perform just fine during periods of transitorily high inflation, but there are two problems with this view. First, the current inflation rate is quite high by historical measures, and many observers think getting inflation back to the 2% target the Fed has for prices will be quite painful. Second, inflation may not be as transitory as some might want to believe. Federal Reserve and administration officials repeatedly argued that inflation was transitory a year ago, but that view no longer holds any weight. Breaking the habit will likely be difficult, and perhaps impossible without causing a recession.
Federal Funds Rate
So far, the most powerful central bank in the world, the Federal Reserve, has been relatively cautious in its response to abnormally high inflation. They have increased their target Federal Funds rate two times to 1%. By historical standards, these two hikes are little in measure, even when viewing the history as the period from 2000 to present. Some might find it odd that the Federal Reserve has been so cautious in increasing rates, when the inflation problem is something people are dealing with now, unemployment is at 3.6%, and unemployment claims are floating near historically low levels. What’s the push against increasing rates faster? Clearly, private asset managers and public markets are having perhaps a large influence on the cautious moves, something that is quite different than what many long-time observers are used to seeing.
Why does the Federal Funds rate matter so much to private equity managers? Besides the effect it has on the broader economy, the Federal Funds rate can affect what it costs fund managers to borrow money, potentially causing some deals to switch from easily profitable to borderline unprofitable.
The Money Supply, M2
The third chart might be a bit of a surprise since money supply is spoken about in the popular press with such nuance, but it perhaps accounts for a good portion of the force behind higher inflation. The figure below is M2, or the Federal Reserve’s second measure of the formal money supply. It includes all the elements of the M1 money supply – cash, checking deposits – and adds savings deposits, money market securities, and other time deposits in amounts less than $100,000. These additions are not perfectly immediate exchange mediums, but can be quickly and easily converted to cash or checking deposits.
Why is M2 so important? Because M2 captures are slice of the money that ends up going to private equity managers and public equities. This money is also a sign of how much funds people have available to spend – a clear driver of the historically strong American consumer.
Summing Up
Overall, private equity mangers are watching economic charts carefully these days, including trends in inflation, the Federal Reserve target rate, and the money supply. Time will tell if these charts end up telling the predictive story of what’s in store for the global economy.
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