Heisenberg Report

Booms Don’t Die Of Old Age, They Are ‘Murdered’ By The Fed

Look, there are things that are “top of mind” over at Goldman, ok?

One of the things that’s “top of mind” at 200 West is “making money.” And in that regard this low vol. regime is a real pain in the ass … errr.. “mind.”

You can rest assured they’ll figure that out, even if it means becoming the first blue chip bank to open a Bitcoin trading operation. So don’t worry about whether the employees over there are going to go broke, because they’re doing ok – as far as I know, the average annual compensation is still well in excess of $300,000.


But “making money” isn’t all that’s “top of mind” for Goldman. Another thing that’s “top of mind” is the cycle and more specifically, where we are in it.

Because a lot of folks think where we are is “late” and if that’s the case, well then one wonders how exactly policymakers are going to be able to lean against the wind when the cycle turns given that we’re all still mired in NIRP and ZIRP and central bank balance sheets are not only bloated, but in fact still growing pretty much everywhere except in the U.S. Here’s Goldman’s Allison Nathan:

More than eight years into the US economic expansion— already the third-longest in post-war history—there are few signs that it will end anytime soon. The lack of inflationary pressures despite the closing of the US output gap—a good predictor of recession risk historically—sends a reassuring signal. And even the fundamental risks we are watching closely, such as corporate re-leveraging and commercial real estate (CRE), do not appear likely to derail the recovery in the near-to-medium term.

But with US equity indices at record-highs, 10-year Treasury yields only moderately off their lows, and valuations arguably looking stretched for both, whether “no recession” also means “no correction” is Top of Mind. 

Right. And it would be a real pain in people’s “minds” if risk assets were to correct in the absence of a recession to blame for the correction.

We’ll get into this more later (maybe), but for our purposes here, it’s worth noting that in one interview Goldman conducts as part of their latest “Top Of Mind” note, Omega’s Steve Einhorn reminds you that there are a number of data points which suggest we are not in fact late cycle. To wit:

First and foremost, the unemployment rate likely overstates the tightness in the labor market and how far along we are in the economic cycle. That’s best evidenced by the fact that, notwithstanding a 4.1% unemployment rate, wage inflation is moderate at around 2.5%. I would also note that the spread between the underemployment rate and the unemployment rate is still above average and the prime age employment-to-population ratio is still below average, both supportive of the notion that the labor market is more mid-cycle than late-cycle.

Beyond these observations, there is an almost unending number of metrics that suggest we are more mid-cycle than late-cycle in economic activity. The GDP gap, which measures output versus potential, has—almost without exception—been above zero and declining before we entered a recession during the last 40 or 50 years; today, it is below zero and rising. The share of cyclical components of GDP—consumer durables, residential investment, capital spending—is typically above average late in an economic expansion, but today it is below average. The Conference Board’s leading economic indicator composite is typically declining year-over-year six to nine months before the beginning of a recession, whereas it is currently up. The unemployment rate is typically up year-over-year late in the economic cycle, but it is now down. Inflation usually accelerates late in the cycle, but today it is moderating. Real money supply growth typically sinks late in the cycle, but it is now stable-to-growing. The fed funds rate is typically above Fed estimates of the neutral funds rate when we are late in the cycle, but today the funds rate is probably less than half of the neutral rate. The yield curve typically has a flat-to-negative slope late in an economic expansion, but currently the slope is positive. And credit spreads, which normally widen prior to the end of an expansion, are tight and stable-to-narrowing.

I have more examples, but I think those are enough to indicate that we are nowhere near a recession, that the probability of a recession anytime soon is quite low, and that mid-cycle characterizes the current economy better than late-cycle.

Ok, thanks Steve. But here’s the thing: Einhorn goes on to tell Nathan the same thing that everyone else has been saying lately. Namely that the risk here is a sudden upturn in inflation that catches everyone (including and especially the Fed) off guard. Here’s Steve one more time:

Neither economic expansions nor equity bull markets in the US die of old age; they are murdered by the Fed. So when you ask what the big risk is, the answer is problematic wage and consumer inflation—i.e., an outcome that turns the Fed hostile. A faster-than-expected rise in inflation is what would make the Fed willing to crunch the economy and bring about recession, earnings disappointments, and balance sheet challenges.

There you go. Everything should be fine as long as that inflation the Fed has been trying to create doesn’t suddenly show up and force Jerome Powell to “murder” us in our sleep.

For now we’ll leave you with a pretty epic annotated chart of historic U.S. booms and busts: