It’s becoming more difficult to shake the feeling that something bad is about to happen to the US economy, markets or, quite possibly, both.
“We need to recognize that we’ve got an overheated economy that we are going to need to cool off,” Larry Summers said, in remarks that made headlines Friday. He was speaking to Bloomberg’s David Westin, for this week’s edition of “Wall Street Week,” a program which, over the past 12 months, morphed into a kind of personal forum for Summers to wax semi-hysterical about the perils of Joe Biden’s economic policies.
The problem is, Summers was mostly right, with the obligatory caveat that when it comes to economics, a soft science, no one is ever right on purpose — only by accident.
He went on to suggest that “Washington policymakers” are placing too much emphasis on supply-side issues. “We are basically moving towards higher entrenched inflation,” Summers warned, adding that,
It’s there in expectations. It’s there in wages. It’s there in labor shortages. It’s there in the pervasive pattern across many different prices. The Fed’s going to have a very real challenge cooling the economy off and doing it in a controlled way. That has not been done very successfully [in] the past.
Asked whether Brian Deese is correct to assess that resolving supply chain issues will, for the most part, clear things up, Summers was unequivocal. “No. He’s wrong,” Summers told Westin. “We have a massive, overheated labor market,” he continued, citing labor shortages “in everything from psychotherapy to McDonald’s.”
Not that anyone needs a reminder, but the latest JOLTS data showed 4.5 million people quit a job in November. A million of those came in leisure and hospitality alone. The figure (below) speaks volumes.
Try as they might to project calm, Fed officials are plainly worried. Charles Evans on Thursday said policy is “not well positioned” for inflation. And Christopher Waller told Kathleen Hays that although three hikes for 2022 is still “a good baseline,” persistently high inflation could make the case for “four, maybe five, hikes.”
Unfortunately, the data is starting to roll over. Friday brought a spate of poor numbers including a horrendous drop in retail sales, a lackluster read on sentiment and an unexpected drop in factory output. If growth decelerates just as the Fed embarks on an aggressive tightening campaign… well, that’s a noxious mix.
“Inflation is an economic and political problem,” BofA’s Michael Hartnett said, on the way to joking that “Joe needs 50bps from Jerome at the January FOMC meeting.”
Obviously, that’s not forthcoming. A hike this month would be a shock to markets. A 50bps hike would be positively jaw-dropping, not because it couldn’t be justified, but because in the era of forward guidance and cooperative policy scripting with the market as co-author, blindsiding traders is a non-starter. Never mind that the taper isn’t complete.
“As the Fed enters the pre-meeting period of radio silence, the tone has unquestionably been established as one of eagerness to begin combating inflation,” BMO’s Ian Lyngen and Ben Jeffery said Friday, noting that headed into the FOMC meeting later this month, there’s “been chatter about an even earlier end to QE in anticipation of a March hike.” Any such move would be immaterial from a mechanical, flows perspective (it’s just one month). But the signaling effect would be important. Frankly, it might do more harm than good to the extent it telegraphed panic.
Despite a bounce on Friday, the dollar just logged a fourth consecutive weekly decline. “Global investors’ belie[ve] the US is fading fast,” BofA’s Hartnett wrote, in the same note cited above. “Dollar debasement [means] yields up and dollar down,” he added, drawing a historical parallel via the figure on the left (below).
Somewhat ironically, cash may not be the worst place to hide (figure on the right, above).
The Fed, Hartnett warned, is poised to be “very hawkish” for the next nine months. On his view, stocks and credit will post negative returns this year driven first by a rates shock and then, in the second half, a “likely recession panic.”