Yesterday the Federal Reserve reiterated its stance they would do anything within their power to support the recovery. Their “dot-plot” shows the Fed Funds rate projections staying near 0% through 2023.

We are in uncharted waters, how can you properly value a company when the risk-free rate is below 1%. But that’s not my main thoughts.

As an investment manager, my first thoughts are always about assessing risks. I believe investors should consider their own risk profiles before they even begin thinking about reward potential.

To this end, I wonder if the Fed is promoting a stance that is too “dovish”, running the risk of upsetting market expectations down the road. I get that their main thesis is the job market is going to take a while to recover, so inflation expectations are low for the foreseeable future.

But as depicted in the chart above, the M2 money supply increased dramatically in response to COVID. In fact, it was larger than at any time during the 2008 financial crisis.

Now, an increase in the money supply alone won’t stoke inflation. That’s why those who have been predicting inflation for the last decade have been wrong. As long as there is demand for safe dollar-denominated assets, the risks of inflation are low.

The Velocity of Money chart above shows the increase in the money supply is directly addressing the demand for safe assets (not inflationary). Ironically, it is a return to confidence – on a macro scale – that could become the Fed’s biggest problem.

So the Fed is following the post-2008 playbook when the 2020 recession was completely different. 2008 was a result of huge imbalances in the middle of a declining economy, while 2020 was a result of an unforeseen event in the middle of a growing economy.

My point is a return to confidence could come faster than the Fed is forecasting. I would not be basing my investment decisions based upon these projections.

So what to do? The old adage is “don’t fight the Fed”. Central banks have had a poor track record of producing inflation. But they usually get what they want, eventually. Now that the Fed has specifically shaped policy with the goals of boosting inflation expectations, I wouldn’t be surprised to see this play out. Especially when the virus dissipates.

Long term investors could be benefited by adding Treasury Inflation-Protected bonds (TIP) to their fixed income exposure, and a value/high dividend fund like VYM or VTV to their equity exposure (as current income distributions could become more valuable than longer term growth if inflation rises).

I’m not a huge fan of Gold but have added about 5% to my portfolio when the Fed dropped short term rates back to 0%. Fundamentally speaking, negative real rates is often supportive for higher commodity prices.

The bottom line is no one knows exactly how this will all play out. We are in uncharted waters on a variety of different fronts. But investors should be prepared for a variety of different outcomes. We haven’t had to worry about inflation for decades, but the markets are cyclical by nature. And oftentimes secular trends begin at the point when no one believes they will happen.

Time will tell!