A return to the Great Moderation Era looks unlikely, which might lead to an increasingly volatile—and somewhat unfamiliar—inflationary, economic, and geopolitical landscape.
It's human nature…or perhaps investor nature…to be myopic at times and focus on the short-term; especially recently with hyper-sensitivity to all things inflation and the labor market, given uncertainty regarding Federal Reserve policy. Every day, the probabilities around what the Fed will do at the next one or two Federal Open Market Committee (FOMC) meetings are pored over by investors trying to gain an edge. If only the Fed would ease its foot off the economic brake, we might assume the inflation dragon had been slayed and we could return to something resembling the pre-pandemic era. How likely is that?
Let's widen the lens and ponder the possible transition we're in the midst of, to perhaps a different secular environment. The secular era that preceded the pandemic is often referred to as the Great Moderation; one during which disinflation reigned, economic volatility was subdued—save for the global financial crisis—and there was a steady tailwind associated with the epic decline in interest rates.
The Great Moderation era doesn't have an official start point, but in general it's seen as kicking in during the 1990s, although some references date as far back as the early 1980s. The era was punctuated by a number of key characteristics in addition to low economic volatility and disinflation; including longer economic cycles with less frequent recessions, a Fed quick to press the easy policy button all the way to zero, profits representing an outsized share of gross domestic product (GDP), and a positive correlation between bond yields and stock prices.
The era that preceded the Great Moderation and started in the mid-1960s—which we've been calling the Temperamental era—had a very different set of characteristics. They included heightened economic volatility with more frequent recessions (but sharper expansions), as well as greater inflation and geopolitical volatility. It was also an era when labor, via wages, represented a much larger share of GDP relative to profits, and when there was a consistent negative correlation between bond yields and stock prices.