It Persists, Now What? Thoughts on Inflation, Growth, the Economy and Life in General

 

I have been waiting for the past 3 plus months to see what, if anything, would happen to the economy, inflation, Fed policy and life in general. So as to not keep you in undo suspense, life in general is pretty good and you should think so too. In regard to the other items listed, well... let’s just say life is unsettled and somewhat predictable at the same time. Looking at the drawing at the left, I think we are in a similar type of stalemate with little movement but lots of energy being expended.

                There has been some discussion about basic economic indicators being outdated (Reuters article, March 12, 2024, see below).  One of the classic leading economic indicators, has always been an inverted yield curve which is predictive of a coming recession, is thought by some to have become unreliable. They are suggesting that since the yield curve has been continuously inverted for 2 years now a recession should have happened. However, there have been external forces that have played havoc with the basic economic conditions including a Fed policy that some say is distorting the entire economic landscape. Since the 2007-2008 great recession Fed policy has been almost continuous stimulation of the economy through aggressive use of the Federal balance sheet (expanding money supply). Many argue that this tremendous infusion of money has distorted many economic indicators and caused many traditional relationships to be broken or grossly strained. The Fed has been reducing its balance sheet holdings for many months but the government has been spending and requiring additional funding for various programs and regulations. The overall balance sheet is sort of being reduced but only sort of. This may account for some of the limbo that rates seem to be in and the uncertainty we see and feel in the economy. It’s like stomping on the gas and mashing the brakes at the same time. The engine of the economy is racing and roaring  but are we slowing down or going faster? It’s hard to tell. In our current case it seems we still have some little forward movement. We are playing a different economic game and we don’t really know the modified rules or the scoring. Does that convey enough uncertainty because that is really what the Fed officials, governmental leaders, talking heads and economic news forecasters are suffering, gross uncertainly. And this uncertainty is lasting a long, long time from an economic standpoint. Back to the original question. Has the inverted yield curve failed as a predictive economic tool? Maybe, and maybe not. The underlying assumptions have been modified by Fed actions and governmental spending activities and we don’t know enough to understand the full consequences or implications.

                The second article (Reuters, April 29, 2024) suggests that “inflation and the labor market remain resilient. …Inflation remains stubborn despite slowing late last year after 15 months of aggressive rate hikes that the Fed halted in July. Data on Thursday [April 25^th] showed that core U.S. personal consumption expenditures inflation rose 3.7% in the first quarter, after growing 2% in the fourth.”

Central banks are suggesting in their comments that they hope to cut rates, relatively soon. However, the data doesn’t support this type of action, not if central banks want to reduce inflation. They are faced with a dual problem of strong economic growth and persistent inflation. The fix for this is higher interest rates, not lower rates as suggested by various central bankers. Talk of lower rates may stimulate market participants to be more bullish with the aim to increase growth in the stock market. I suspect the idea is to make current governments “look good” before elections. Pres. Biden has been saying the common man is doing so very well with the strong economic growth and high employment. The problem is that we have had very high inflation which has destroyed the real purchasing power of money. Yes, we are producing more but the cost to purchase is so very much higher. People are employed but they aren’t earning enough to afford the higher prices of things. So, yes, we are in a strong economic situation and we can’t afford it. But then you already knew that.

                The 3^rd Reuters article of May 8^th is interesting in a negative sort of way. Quoting from the article,

  “A slowdown in activity will be needed to ensure that demand is better aligned with supply for inflation to return durably” to the official target, Collins said in remarks to be delivered at a Massachusetts Institute of Technology event.

What she said was the Fed doesn’t believe it has reached a point that inflation will return to the benchmark 2% target on its own. The economy is too hot. Quoting from the article again,

 In her remarks, Collins said “overall, policy remains well positioned to respond to incoming information, as we assess the evolving outlook and risks.” She also said she’s “optimistic” the Fed can get inflation to 2% “in a reasonable amount of time, with a labor market that remains healthy.” That said, getting inflation to 2% “will take more time than previously thought,” with Collins noting “there is no pre-set path for policy – it requires decisions based on a methodical, holistic assessment of wide-ranging information.”

                Welcome to Fed speak. Let me see if I can dissect this a bit. Collins is trying to avoid the comment that she doesn’t think the current Fed Funds rates will be sufficient to bring down inflation any time soon, which is what people want, a quicker solution. We have had almost 2 years of trying to get down to 2% inflation and she isn’t confident they can do it soon. She says not to worry, that the Fed is watching but that “getting inflation to 2% “will take more time than previously thought,” with Collins noting “there is no pre-set path for policy – it requires decisions based on a methodical, holistic assessment of wide-ranging information.” That means they (the Fed) believe they can do it but that current activities may not be enough based on information that they currently don’t have but are willing to consider when they do have the information they currently don’t have. But what that information may be that they currently don’t have is uncertain at best. Makes perfect sense in a non-sensical sort of way, … don’t you think. So Collins is saying don’t worry, we know inflation is high and we are trying to get it down to 2% but we aren’t certain that current policies will accomplish that goal. We certainly aren’t certain how long it will take once we are more certain. If we were more certain we certainly would have a certain answer for you, but we certainly don’t at this time. I’m pretty certain that is certainly what she is trying to convey, certainly.

We can worry about the certainty or uncertainty of governmental leaders, Fed officials, financial commentators and the general economy but that isn’t what is important. I keep coming back to this theme again and again because it is important and if you will allow the use of an over used word, certain. We are certain about our relationships with family and friends and that we need to strengthen and improve such things. We are certain we live in a good land and can enjoy the beauties around us. We are certain that there is a God and he is aware. And we are certain that there are people who care and are interested in us and how we are doing. That is what is really important. We will survive this economic situation and why would we want to spend our time worrying about something when we can be improving ourselves and those around us and enjoy the beauties of a new spring and summer before us. About that I am absolutely and completely certain.

 Articles Consulted:

REUTERS, March 12, 2024, Inverted yield curve no longer reliable recession flag, strategists say,

https://www.reuters.com/markets/us/inverted-yield-curve-no-longer-reliable-recession-flag-strategists-say-2024-03-12/

REUTERS, April 29, 2024, Inflation-wary US rate options market cautiously prices for 2024 Fed hike,

 https://www.reuters.com/markets/us/inflation-wary-us-rate-options-market-cautiously-prices-2024-fed-hike-2024-04-29/

REUTERS, May 8,2024, Fed's Collins says economy may need to weaken to get 2% inflation, https://www.reuters.com/markets/us/feds-collins-says-economy-may-need-weaken-get-2-inflation-2024-05-08/

REUTERS, February 21, 2024, Fed worried about cutting rates too soon, minutes of January meeting show, https://www.reuters.com/markets/us/fed-concerned-about-cutting-rates-too-soon-minutes-january-meeting-show-2024-02-21/

Looking Through a Dark Glass - Old models rethought, New playing field

 

Photo by Barbara Platek

I have waited to write another blog on the economy because things have been slowing down a bit lately. Slowing down is a relative term of course. Financial news and gurus would like nothing better than to have massive activity or perceived activity to generate something to write about. It doesn’t matter what point they argue just that they can argue. I have found three articles discussing topics that I think may be interesting and possibly somewhat informative.

The first two articles are from the Financial Times and CNBC, written in mid and late December. I like them because someone is asking about how successful the various central banks have been in predicting and handling the most recent recession and interest rate crisis. They have not been particularly successful in either predicting or dealing with the crisis. The article is pretty good about pointing out a couple of good thoughts. However, the central banks only admit that they applied the wrong thinking to the problem. They now know where they went wrong (or so they say) and the problem won’t happen again. Don’t believe them. They haven’t got it right this time. We will continue to have crisis and they will continue to make the wrong corrections.

Central bankers are rethinking their approach to economic forecasting after their high-profile failures to spot the most recent inflationary outburst, as officials argue for greater candour with the markets about the uncertainties they are confronting. … “What we should have learned is that we cannot just rely only on textbook cases and pure models. We have to think with a broader horizon,” she said. (Christine Lagarde) (a)

The second article discusses the difficult nature of forecasting. If only the world were linear or bell curve shaped or predictable our models would have performed just fine. But because the world is unpredictable (who would have thought) we (the economists and central bankers) can’t be expected to be able to make accurate forecasts. So we will continue to use the old models with a few adjustments and expect the world to get in line and be linear or bell curve shaped. Because if it does conform to our view of the world then, of course, our models will get it right. Their models will not get it right, trust me on this.

Firstly, a “multi-polar world” and an “increasingly fragmented global order” are leading to the “end of hyper-globalization,” Little said. Secondly, fiscal policy will continue to be more active, fueled by shifting political priorities in the “age of populism”, environmental concerns and high levels in inequality.  Thirdly, economic policy is increasingly geared towards climate change and the transition to net zero carbon emissions. [More so in Europe but the Biden administration is determined to drag the US into the morass of massive spending, extreme regulation and ill-thought out initiatives.]

“Against this backdrop, we anticipate greater supply side volatility, structurally higher inflation and higher for longer interest rates.” Little said. “Meanwhile economic downturns are likely to become more frequent as higher inflation restricts the ability of central bands to stimulate economies.” (b)

 

New interest rate & inflation thinking

I like the below quoted Reuters article from early January. There is still a lot of sentiment that the Fed will be successful in a soft landing. You will notice that this discussion has been going on since early 2022 with an ever changing end date. The discussion of the recession, regardless if it crashes or is in fact a “soft landing” makes for good press so as long as it is never resolved there is good storytelling. Expect to see much discussion even after it is finally decided we are either in recession or had a soft landing

 “[A] well-known economist and former Fed official earlier this year argued the Fed has managed soft landings more often than is generally believed. But many investors and executives think the probability is low [for a soft landing at this point].

Investors are betting that the Fed could cut rates by as much as 1.5% by the end of 2024, but that would still leave policy rates at close to 4%, higher than where it has been for most of the past two decades. At that level, monetary policy will still be a drag on growth, as it would be above the so-called neutral rate at which the economy neither expands nor contracts.” (c)

What does this mean for you and me? More uncertainty and higher interest rates for quite some time and the likelihood of rollercoaster inflation and less inflation. For the last 30 years we have had it fairly nice. The central banks kept interest rates artificially low by pumping massive amount of money into world economies. We all benefited from cheap money. We are now, finally paying the price because the banks can’t kick the can down the road anymore. There was so much excess money (the central banks have actually been reducing their balance sheets some recently) that the whole world system began to collapse. That was when the world banks finally panicked and slowed the river of money. That is the catalyst for the current recession (starting in early 2022) and why it is still hanging on. Most previous recessions lasted from 4 to 10 months at the longest. We are still drying out from our massive, massive binge and it is being slowly done. So expect to see recession / inflation talk to continue (remember it makes for good press). See excerpts from the Reuters article below to see a pretty good discussion of what can and may very well happen and why.

“Interest rates underpin everything, from economic growth to the price of financial assets and how much it costs to borrow to buy a car or a house.

Higher rates make riskier assets, such as technology stocks and cryptocurrencies less attractive, as investors can earn a decent return without having to take on much risk.

With money harder to come by, riskier bets can fail and bubbles burst, leading to events such as the U.S. regional banking crisis last March. As businesses struggle, they retrench. People lose jobs and new ones get scarce.”

“While the Fed and other banks have been raising rates for well over a year, the world is yet to complete the transition from the time when money was free to a period when it no longer is. 2024 is likely to be the year when the effects of that transition manifest more clearly.

That means companies – and in some cases, entire countries -- will have to restructure their debt liabilities, as they can no longer afford to pay interest.

For consumers, while savings would yield more, higher borrowing costs will require an adjustment. Many U.S. adults have only known low interest rates for their 30-year mortgages, for example. They'd need to come to terms with rates that are more than twice as high and make the math work for their budgets.

Bottom line: investors' convictions will likely get tested, as everyone will have to figure out how to live with higher interest rates.” (c)

So, hang in there. Us old timers (me included and my generation) lived through this kind of uncertainty and massive upheaval in the 70’s and 80’s. We survived. We had to be more frugal and things cost more including anything that required borrowing or debt. Because the costs were higher we had to scale back on our expectations and it did impact our ability to spend and save. When we came out of that time period the world governments opened the money spigots to keep inflation low because they were so afraid of inflation that they would do anything to avoid it again. It appeared to work for 30+ years. Now it doesn’t work and you (the younger generations) are paying the price as are we. My generation went from tight money to loose money and we loved it. This younger generation is going from loose money to tight money and it is painful and will be so for a while. Good luck. Remember what is important and it isn’t easy money. It’s family, friends, neighbors and your spiritual wellbeing. Not what the world would have you believe.

Articles quoted:

‘(a) Financial Times, “Central banks rethink forecasting after failures on inflation”

Sam Fleming in London, Martin Arnold in Frankfurt and Colby Smith in Washington 

December 27 2023  https://www.ft.com/content/5d7851f3-ef7c-4599-8a5c-c34cecb83511

‘(b) CNBC ‘Bonds are back’ as markets enter a ‘new paradigm,’ says HSBC Asset Management

Published Thu, Dec 14 2023 2:45 am EST  https://www.cnbc.com/2023/12/14/bonds-are-back-as-markets-face-new-paradigm-hsbc-asset-management.html

‘(c) REUTERS, “For investors, 2024 is year of transition to a new economic order”, By Paritosh Bansal, January 2, 202410:07 am MST  https://www.reuters.com/markets/investors-2024-is-year-transition-new-economic-order-2024-01-02/