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                There has been some discussion about basic economic indicators being outdated (Reuters article, March 12, 2024, see below).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/

Recession, Banks, Debt Ceiling – You Must Believe Me Now

The question is, if it’s said loud enough will it be believed? Because this time it really is true (it is being said very loudly). Or is it?

The discussion about recession has been on-going for some time now. I started writing about recession possibilities over a year ago. The discussion has moved back and forth between how do we avoid one to how do we get a soft landing to what can we do to help those that will likely suffer if the landing isn’t so soft. We may see in the next several months various pronouncements by various talking heads. You notice I didn’t say anything about what phase this is. I don’t know and it doesn’t matter as much as most news personnel would like you to believe from their  strident and every increasing noise. Remember, it is important to keep the fans whipped up. We will be able to look back in several months when the National Bureau of Economic Research (NBER) will state that a recession started at such and such a point, or didn’t. Remember, only the Bureau is recognized as the official group that can declare such and they always include factors that are backward looking, meaning we don’t officially know until after the fact. This also means that we don’t officially know if we have had a soft landing, missed recession or face plant until after the fact either. There are other signs that may give us indications of various outcomes, however. We have been moving toward this point for months and months. It is dragging on longer than a normal news cycle so it gets recycled regularly. Expect to see it to continue. Again, the fans need to be whipped up to keep enthusiasm high. We are getting more comments like JPMorgan Chase CEO, Jamie Dimon (CNBC, Apr 14, 2023 Manie Dimon issues warning on rates: ‘It will undress problems in the economy’) that investors and business should plan on interest rates remaining higher for longer. The Fed still needs to “dry out” the economy, get the excess funds (easy money) out of the system. That hasn’t changed. We still have a recession we are trying to work around or work through depending on what you think may happen. Work around implies a soft landing or just a slowdown; The economy slows down, unemployment rises a bit. Banks tighten their lending policies. A few business and individuals suffer or go under. The Fed is able to get their balance sheet down without the stock and bond market tanking (it slows down, drops and recovers fairly quickly). We stumble a bit and slow down. No or mild recession and we carry on at a more measured pace. Work through implies a recession; we trip or worse, face plant and have to pick ourselves back up. We see bank failures, businesses and individuals declare bankruptcy. The Fed isn’t able to maintain a smooth decrease in its balance sheet or worse doesn’t reduce it. The stock and bond market react to all the uncertainty and failures by tanking. It takes a longer to climb out of the hole.

One of the consequences of the higher rates is the financial sector including banks will feel the pinch. They have to change from an easy money mentality to a more measured lending stance. Easy money implies less diligence in protecting deposits and in shoring up a banks balance sheet. There is little or no profit in protecting deposits (lending them out is where money is made) or doing more than the minimum required or skirting regulations. Most banks try to balance the profits with the safety, we have seen the banks that didn’t. The price for skirting the safety regs in good times is minimal and it is hard to see which banks may be skirting until too late when times turn bad. The best we can do is go with financial institutions with a long record of being conservative. Credit Unions tend to be more conservative by their nature and charter requirements. Still, it’s hard to tell. There is something to be said for spreading money around between institutions. We also have deposit insurance which is helpful but in the Silicon Valley Bank and First Republic Bank failures the Fed stepped in and guaranteed all deposits which stressed the insurance provider FDIC (it almost broke it such that another big hit would cause serious problems). So, things are complicated, of course. By guaranteeing all deposit they essentially gave a green light to the poor practices of the bank. They also prevented a bank run on several similar shaky banks across the country. Whether that was the right thing to do or not should be debated for a long time. The current mentality is that the government can fix everything which makes them responsible. Hence more regulation and laws and more places for shady people to find loopholes. Notice that the defense for many of these funny practices is that the entity did nothing wrong, they were following the rules. It was the rules fault. So, of course, more rules are needed. That is a very bad spiral and you can follow it down to the final conclusion. Watch the financial sector for more stress in general and how they seem to take care of it. Look for more rules and regulations. I am glad I am finishing up my career in finance and not starting it. It is a very different and much more difficult place to work then 30-35 years ago when I was first involved.

                Now the debt ceiling question. I am not going to quote any articles. There have been so many. It is the current hot, hot, hot topic button and the news media are mashing it with their biggest and most massive sledge hammers (gleefully I might add). Do you feel like you have been beat up no, pummeled for weeks on end. Everywhere you turn someone or some organization is talking dire straits, doom, gloom, death, destruction, mayhem, the very end of the world as we know it, the end of civilization, the death of all we hold near and dear, (pause for dramatic breath!!!!!!) AURRRGHHHHHHHH. Why can’t you people see how important this is!!!!!!!!!!!

Sorry…., I got just a little bit carried away.

It won’t happen again (at least until tomorrow anyway.)

                This is the news and financial media at its finest. This it the current news media model and the debt ceiling is the ultimate opportunity to exercise its model to the fullest. The underlying question is the government has set some limits on its spending capability, a good thing. It has come around again that the government can’t manage its input and output. The easy solution is raise the debt ceiling or remove the debt ceiling requirement or better yet get spending under control. Now, granted, the answer is never that easy and that is also part of the problem. The solution is pretty complex but workable. However, we have powerful political forces that are using this debt ceiling to push their various points and agendas.  

As background information. The following is from Wikepedia, United States debt Ceiling;

The U.S. has never reached the point of default where the Treasury was incapable of paying U.S. debt obligations, though it has been close on several occasions. The only exception was during the War of 1812 when parts of Washington D.C. including the Treasury were burned.

In 2011, the U.S. reached a crisis point of near default on public debt. The delay in raising the debt ceiling resulted in the first downgrade in the United States credit rating, a sharp drop in the stock market, and an increase in borrowing costs. Congress raised the debt limit with the Budget Control Act of 2011, which added to the fiscal cliff when the new ceiling was reached on December 31, 2012.

The last time things got too close, government set new rules and they immediately went about figuring out where the loopholes are. And it is continuing. Is it a problem. Yes. Is it the end of things as we know them (as the news is telling us). No. Are there solutions. Yes. Should you be upset. Yes. Should we be acting like Chicken Little. No. It will play out. It will get close. There will be much rejoicing in the media when the “solution” is reached. Then the media will begin the analysis phase which will allow for continued coverage for many months. So it continues. Should you follow all the stories. DEFINATELY NOT. When this crisis passes the media will need something else to keep us tied to them. Look for the recession to come back in vogue. Don’t be lead around. The various financial crisis will continue in the news. You can always find them if you want. I suggest you don’t want to. Keep your finances simple. Keep debt low. Save as you can. Debt is good for some things, housing, education, transportation. Live simply.

                Remember what is important. It isn’t news. It is family, friends, the things you love. It is the beauties around you. It is relationships, the good earth, the joy of interacting. It is game nights, movies together, playing with kids (big and little ones). It is in quite walks, talking in person to friends and family. Meeting new people, a meal together, building something, watching a sunrise and sunset. Tell someone you love them. Share precious things, a hug a kind word, hope.

Bank Failure, Recession – What Is Happening

 

        I am composing this blog while listening to 5 songs, playing loudly, Living the Dream by Foreigner, Demolition Man by Sting, Bang a Drum by Jon Bon Jovie, Wheel in the Sky by Journey, and Dr. Heckyll & Mr. Jive by Men at Work. Mainly because they sound good loud, better louder, especially with more bass. The lyrics are a good mix of some of my feelings regarding the economy, economic policy and the people playing the various roles in this current economic play (especially Bang a Drum).

                I haven’t said anything for a few weeks as I was waiting for the news noise to settle down and we can pick through the points in a more reasoned manner.  The Associated Press article titled Fed raises key rate by quarter-point despite bank turmoil by Christopher Rugaber (3/22/23) is a good summary of the past several weeks and may hold some insight into future activities. I have put a link to the article at the end of this post.

                First, bank failures. The problem is 3-fold. One, with the Fed raising the Fed Funds rates and attempting to dry out the economy by removing money from the economy, all borrowing costs have increased as well as interest rates on all new debt instruments. Treasury rates have changed wildly and are higher across the board. Don’t worry about short term vs. long term differences, just know all rates are up, up a lot. The purpose is to remove money from the overall economy so that too much money is not chasing too few goods (one of the basic definitions of inflation). The higher rates affect you in many ways but especially if you have old bonds (bonds at old, lower rates) and you need to get the principal before the bonds naturally mature. Remember, interest rates and principal value are inversely related. If rates go up principal value goes down. However, this only happens if the bonds are sold before their maturity date. If the bonds don’t need to be sold early then no foul, no harm. When they talk about bonds losing or gaining value it only relates to having to sell them before maturity. It’s only a paper change based on current conditions. It is a way of looking at current opportunities vs. what was spent / invested previously. If you have an existing, older mortgage you are saying, boy what I deal I got. If you are looking at invested funds you are saying I wish I had my money free right now because I could earn a lot more if I invested now. You don’t owe any more interest on your mortgage or have fewer dollars coming in from your invested bonds. Now, if you need to borrow new money or invest some current excess funds then the current rates will apply. That is where you will see the impact of higher rates, on any new debt you want to acquire or new investments which will give you more earnings. If, however, you need to get the money out of your current investments you will have a problem which is what all the current news is talking about as lost money. Remember, there is an inverse relationship between rates and principal, as rates increase, principal decreases and vise-versa. In order for you to get your money back early (i.e., sell your current debt/bond) someone else will have to buy it and they are not going to want your old interest rate bond because it has a lower interest earnings rate than what that person can get if they were to take their money into the market today and buy a new debt instrument. In order to make it attractive to the new investor you need to make your old debt equal to the current debt they can get. Debt is equal to the value of the stream of remaining interest payments plus the principal payment. So if the interest payments are lower than current interest payments you have to take less principal to make up the difference (not quite that simple because compounding is also included). So, if current interest rates are higher and you have to sell your old debt then you will get less than the stated principal to make up the difference. If you were counting on that total principal amount you now have less.

                That leads to the second part of the bank failure problem. Banks make money by lending out their deposits and funds to borrowers (no problem). Banks learned a long time ago that they can’t lend all their deposit as they need some funds to cover regular transactions. If people can’t get their money in a timely fashion they won’t invest in the bank. The Fed has set various rules for how much banks must maintain in cash and cash equivalents to meet short term demand. (A discussion for another time is why does the Fed have to set the rules thus removing the need for banks to be their own monitors. That is why we have too big to fail banks and other problems, banks aren’t responsible for their poor decisions because the Fed picks up the responsibility, and cost.) One of the cash equivalents allowed by the Fed is the bank can hold Treasury bonds and high quality municipal debt (bonds). The bank should always be monitoring the impact of changing rates and if rates are moving then what is the value of the principal if the debt has to be sold immediately (can’t wait for maturity). Usually the bank will “hedge” the debt meaning they have various financial products that will allow them to cover the loss in having to sell before maturity. These instruments are not perfect and can have problems themselves.

                The third part of the bank failure. Silicon Valley  and Signature Bank had depositors that included venture capitalists and other very sophisticated investors. The investors realized that the bank was either not hedging their funds properly or had lent out too much in relation to what they needed to cover their short term needs. The investors fairly quietly started taking their deposits back. Problem is many watch venture capitalists very closely. It took only a few days for a run to start on the bank meaning not just a few but lots of people want their money back, now. The bank had to sell their cash equivalent funds (because they didn’t have enough cash) which were in treasury bonds, considered very safe (and they are because the federal government will always pay what they owe) but they had to sell in a rising interest rate market. Investors won’t pay the full principal amount because interest rates are higher than the rates on the bonds. Hence, less principal coming back. The bank sold something like $21 billion in securities and lost $1.8 billion. They needed to make up the difference and tried to sell new stock to raise it. That sent more shockwaves through bank customers which led to a run on the bank. No one wanted to buy the stock. The bank was overwhelmed by withdrawals and couldn’t meet the demand. The Fed stepped in and closed the bank.

                Many are suggesting that the Fed’s interest rate policy led to the bank failures. High interest rates certainly caused the problem of the lost principal when the bank was forced to sell before maturity. The bank was supposed to be monitoring such things. According to reports, the bank’s mix of securities and cash was substantially different (worse) from industry averages.

The Fed this week increased the Fed Funds Rate by only 25 basis points, recently it was expected to be 50 basis points. There is news noise that the Fed should stop, increase, change. There are calls for Congress to do something (more regulation), again news noise. There may well be new regulations but let it sit a bit before you start looking / commenting. Previous Federal policies and regulations made much of this mess, they may or may not be able to do some good. I am not particularly hopeful but one never knows. There is much noise around the Treasury and Federal Reserve’s move that guaranteed all deposits not just those of $250,000 or less (FDIC insured) at the failed banks. That move was to keep the bank runs from spreading to other banks. It seems to have worked at this point but things are still dicey in the banking sector. Questions are being asked about what other banks may have similar situations to SVB and Signature bank. There have been rumblings in other parts of the country. We have had many public officials making official public announcements. Remember news noise, we don’t know yet in spite of all the words. Back to the guaranteeing of all deposits. That releases all responsibility of the banks and the big depositors. The system wasn’t designed to cover those types of costs. Biden and Yellen have promised that taxpayers won’t cover this cost. There isn’t enough money in the FDIC funds to cover the cost of insuring those uninsured deposits. The insurance premiums are collected from bank fees to all banks. You and I pay those fees. I don’t see how we aren’t going to pay the costs. Unless public officials come up with some other plan, we can hope they will. Now we have another precedence set for banks to rely on the Federal government to bail them out, tying them closer still to the government.

                A recession is still very much on the table. The Fed needs to balance the problems caused by tighter policy (higher rates) with the expected problems generated by those policies, yes expected (the problems aren’t new). They also include stalled growth (which is needed but how long might it last), increasing unemployment, higher borrowing costs. Markets really, really hate, loth, fear, you name it, all this uncertainty. They don’t like it and tend to rebel (do things that the Fed isn’t expecting or prepared for – like bank failures). Expect to see this continue. It’s all part of the process. Remember, we have survived this sort of thing before (recession). It is NOT the end of the world as we know it. It is NOT going to go on forever. The sky is NOT falling. (Things you will hear in the news noise.) It is part of the process of getting the economy back on track and working better. It is going to work, it has worked before and it will work again. Hang in there. Remember what is important and that important things are NOT found in news noise. They are found in friends, family, loved ones and enjoying life. It is doing things together and learning new things. It is in seeing all the beauty around us and enjoying that. It is found in loving and caring more.

            I am now stepping off my soapbox and turning down the music volume.

AP news article -

https://apnews.com/article/federal-reserve-inflation-banks-interest-rates-jobs-91a9185ebce972bbf5ab1f46654f1a53