Get Ready for 'Twin Peaks' Inflation

Editor's note: Inflation may seem to be mostly under control today. But according to our colleague Mike DiBiase, the government's recent spending and money-printing spree could be a sign of an impending recession. In this piece, adapted from a recent issue of the Stansberry Digest Masters Series, Mike explains why we're seeing echoes of the inflationary 1970s and '80s – and why a specific group of bond investors don't need to fear... even in a recession.

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The farmers blockading Paul Volcker's D.C. office were out for blood...

Volcker had only been the Federal Reserve chairman for a couple months. But he was already one of the most hated men in America.

You see, Volcker had inherited a mess at the end of 1979. Government overspending in the 1970s on social policies and the war in Vietnam led to budget deficits and a massive increase in the national debt.

By 1974, inflation had climbed to as high as 12%. To combat it, the Fed raised interest rates as high as 13%. Higher rates ultimately choked off inflation... but led to a 16-month recession.

The government's answer, of course, was to stimulate its way out of the mess by printing money. The money supply exploded higher in 1976 and 1977.

Inflation soared again, from 5% at the end of 1976 to 12% by October 1979, with no signs of slowing.

Enter Paul Volcker...

Two months after he was made the new Fed chair, Volcker announced a drastic policy shift: The Fed's primary focus in fighting inflation would be managing the money supply.

Interest rates would need to go much higher. With inflation at 15% in 1980, Volcker raised rates to nearly 20%.

That meant more pain for already hurting Americans.

Farmers drove tractors to the Fed's headquarters to protest. Homebuilders and construction workers stamped messages onto pieces of two-by-fours that they couldn't use for building and sent them to the Fed. Auto dealers sent keys of unsold cars.

But Volcker's hard medicine worked. Inflation sank to around 2.5% by the middle of 1983.

Volcker succeeded where other Fed chairs had failed... because he understood that there was no easy, painless way to cure inflation.

We're seeing a similar situation today...

Just like in the mid-1970s, everyone thinks inflation is tamed. And yet, once again, government spending is out of control – and the money supply is on the rise.

As I'll explain today, a recession is very near. I expect the government will make the same mistake it did in the mid-1970s and try to "fix" the economy with more monetary stimulus.

That will only make things worse. The seeds are in place today for another 1970s-style "twin peaks" in inflation...

The last recession was in 2020, following the pandemic. The Fed responded by unleashing unprecedented monetary support for the economy. First, it lowered interest rates to near zero. Then, it injected more than $6 trillion of new money into the financial system.

This pulled the economy out of the recession after a few months, making it the shortest on record.

But this massive stimulus had a cost. Inflation soared. And the Fed was left with far fewer bullets for next time...

Never before in our history have we seen as much money printed all at once as we did then. You can see this by looking at the U.S. M2 money supply. This is essentially all the money in the system... It includes cash, checking and savings accounts, money-market accounts, and mutual funds.

The money supply soared from around $15 billion at the end of 2019 to nearly $22 billion by March 2022. Take a look...

Since World War II, the money supply has increased about 6% per year. Following the pandemic, it ballooned more than 40% in a two-year span. We've never seen that kind of increase before.

It normally takes a year or two for the increase to show up in higher prices. But it always does... which is why inflation soared from around 2% before the pandemic to 9% by June 2022.

You can see in the previous chart that the Fed began decreasing the money supply in 2022 and 2023. Along with raising interest rates, that helped bring down inflation.

However, there are a few troubling things you should pay attention to...

First, the money supply is still well above its long-term trend of 6% annual increases. That tells me there is still too much money and liquidity in the system.

Next, the money supply is once again increasing. In fact, it has increased every single month for the past 15 months.

And this trend isn't likely to reverse...

The federal deficit is now around $2 trillion per year. The only way the government is going to fund its uncontrolled spending is by selling Treasurys.

The Fed is the Treasury's primary lender. When the Fed buys Treasurys with newly printed money, the money supply increases.

And it will continue to be a massive net buyer of Treasurys for another reason...

When inflation rises, long-term interest rates rise in response. The Fed wants to keep long-term rates down, too, but it doesn't directly control them. The only way for it to lower them is by buying Treasurys in the open market.

This is known as quantitative easing. Quantitative easing also causes inflation.

It's for these reasons I expect the money supply to continue to increase in the years to come. And as long as the money supply is increasing rapidly, inflation will continue to be a problem.

This is exactly why I think we are headed for another "twin peak" inflationary period like the 1970s.

The next recession will likely begin in the first half of this year. The Fed is now forecasting that the U.S. economy will shrink nearly 3% in the first quarter. And I expect economic news over the next few months to worsen.

Consumer savings will continue to dry up, and credit-card debt will keep breaking records. Delinquencies and defaults on credit-card and car loans will continue to rise. So will corporate bankruptcies (which hit levels last year not seen since the aftermath of the last financial crisis).

The negative headlines will eventually sour investors. When it's clear a recession can't be avoided, the high-yield credit spread will rise. I expect the spread to spike close to 700 basis points ("bps") by the middle of this year.

But the Fed will act quickly to calm the markets as best it can.

It will aggressively lower interest rates. And it will ramp up its quantitative easing. This means buying hundreds of billions of dollars of Treasurys in the open market to drive down long-term interest rates that securities like mortgages and corporate bonds are tied to.

It will work... for a while. The recession will end. Markets will recover. The spread will fall as fear leaves the credit market.

But just like in the mid-1970s, this stimulus will be highly inflationary. Inflation will begin to surge again, most likely in 2026. Remember, it takes around 12 to 18 months for large increases in the money supply to show up in inflation figures.

The second wave of inflation will be devastating for consumers, businesses, and investors who don't see it coming. The high-yield spread will soar as investors lose confidence in the Fed.

It will have little choice but to channel the spirit of Paul Volcker. The Fed will raise interest rates much higher and move to aggressive quantitative tightening policies, focusing on reining in the money supply and credit.

This will kick-start the next true credit crisis. I expect the high-yield spread to soar past 1,000 bps as the economy plunges into another recession. This one, however, will last much longer than the one in 2025.

Here's what this forecast looks like in a chart of the high-yield spread (with recessions highlighted in gray). The blue part of the line is our forecast...

For most, this might be a scary forecast... But if you understand credit cycles, you don't have to fear them. Instead, you can use them to make more money in safe, fixed-income investments than you ever thought possible.

It's the best time to "back the truck up" for bond investors. Our Stansberry's Credit Opportunities track record is proof of that.

Our returns have been far better on recommendations we made when the high-yield spread has soared.

For example, when the World Health Organization declared COVID-19 a pandemic in March 2020, the high-yield credit spread spiked to more than 1,000 bps.

Soon after, we recommended eight very safe bonds in our Stansberry's Credit Opportunities newsletter. Our timing was excellent... The wave passed almost as quickly as it came.

The average return of those eight closed bonds was 18% over an average holding period of 112 days. That's a phenomenal 59% annualized return.

So while the coming recession is a legitimate reason for concern, I believe the next few years will be extremely profitable for corporate-bond investors.

Good investing,

Mike DiBiase

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