By now, it feels like a US recession is inevitable.
The headwinds are gale-force, and while I’ve used that (admittedly clichéd) description of the prevailing macro backdrop countless times previous, it’s as apt as it is trite.
It’ll seem obvious in hindsight, as all things do. But really, it seems obvious ahead of time, too. Inflation is the highest in a generation, commodity prices are at levels that can only be “solved” by demand destruction, wage growth can’t keep up with consumer prices except at the very low-end of the pay spectrum, transfer payments credited with helping Americans survive COVID have ended and the Fed is compelled to tighten policy into a burgeoning slowdown.
If you ask Nomura’s Charlie McElligott, a front-loaded Fed hiking cycle that “gets us to neutral fast” is probably the way to go, as it “giv[es] the Fed future optionality across two opposing scenarios” going forward.
One of those scenarios finds the Committee trying to buy themselves some time, in the hope inflation eventually moderates “organically” in the back half of this year, where “organically” means supply chain disruptions ease and a bit of healthy demand destruction sets in. That, McElligott said, “would allow the Fed to slow tightening” and thereby avert a policy error, which in this context means tightening the economy into a slowdown. “By going fast then pausing,” officials can “theoretically improv[e] the odds that the economy could be managed back into a Goldilocks ‘soft landing,'” Charlie said Monday.
The second scenario entails the Fed implicitly adopting some version of a mantra that says “if you’re gonna break it, break it fast.” It’s possible that inflation simply won’t abate on its own, or at least not anytime soon. Even if commodities cool off (say, on a ceasefire agreement in Ukraine), the raw materials surge witnessed over the past several weeks will still need to work its way through. And that’s to say nothing of the various logistical disruptions associated with Russia’s invasion which, in addition to pushing up commodity prices, has also curtailed production, constrained the movement of goods and pushed up the cost of transporting commodities. In other words, the conflict threw yet another spanner in the supply chain works. Not only that, China’s new lockdown likewise has the potential to impact global shipping and supply.
An “exten[sion] of the inflation shocks [would] perversely require global central banks to seek to ‘hike us into a recession’ so that a growth crash works to destroy demand and regain control over inflation,” McElligott went on to say. The figure on the left (below) shows Nomura’s Fed assumptions.
The figure on the right (above) shows, as Charlie wrote, “the market expects the hiking cycle to be completed by early / mid ’23, while a full-blown inversion in EDZ3-Z4 shows the Fed’s guidance will turn outright dovish towards easing in ’24.”
Frankly, I’m finding it difficult to countenance the notion that the Fed will somehow be able to distribute all the hikes the market expects for 2022 over the full year. It’s becoming harder and harder to envision a scenario where the economy looks any semblance of robust in the second half, and given the rapid approach of the midterms, it seems far-fetched to believe the Fed would be willing to proceed with what, by September, will already be a string of rate hikes into a decelerating economy.
I don’t see that as a viable policy trajectory. It’s more likely, I think, that the Fed attempts to front-load the majority of this year’s planned hikes, squeezing in more than 100bps by Jackson Hole, in order to give themselves scope to pause in September, lest they should “succeed” in engineering a hard landing at a politically sensitive juncture.
Of course, trying to squeeze in that much tightening in such a compressed window could be highly disruptive. There’s not going to be a soft landing.
So where to park?
Even with rate hikes- there are still extra trillions and trillions of USD and euros, among other “reputable” currencies, that were printed the last 24 months, which all need a parking spot.
I am still surprised that some still think hanging out in bonds will be a good idea during the upcoming time period – with the “known” inflation.
Maybe in terms of a real return, it might be difficult to beat inflation but where to go to minimize the potential negative real return? Seems like real estate and US equities are as safe a bet as there is.
It is a puzzle, parking, that is. When something is in demand we’ve been conditioned like Pavlovian experimental subjects to expect to pay more. Probably better carry more tokens (coin that is) for those meters.
@H has mentioned the simple virtues of cash occasionally … as a risk management tool cash has some very unique and potent qualities. Building up cash should of been recognized as inevitable some time ago for any but the hard-core to-the-bitter-end type of buy-and-holder, or the younger bolder buy-and-holder with decades of human capital remaining. The same ‘forces’ that lead to building up cash holdings also strongly suggest careful/conservative bet-sizing going forward until you are very satisfied with what you believe is a “margin of safety” offer to good to refuse. I’m not there yet for the broad indexes.
As an aside, when considering the problems we investors must face these days, there is also the Asset Manager Capitalism (AMC) phenomenon to ponder like never before. Talking about State Street, Vanguard, and Blackrock owning just shy of 25% of every component in the S&P 500. Much to complicated to go into here, but, I’ll wager if I search THR I’ll find @H will have expressed some thoughts on how it is yet another gilded force for inequality. The Finkster would like to think he controls the sphincter of the ESG movement where it melds with the mouthed goals of policy maker brain-droppings, that is, at least according to how some would interpret Fink’s statements. I guess I’m thinking of Adam Tooze and friends like Mark Blyth. Blyth I remember because he was new to me and I looked at his adversarial position recently, however, people seemingly from every political persuasion and niche in the Financial Industrial Complex have been trying to divine the ultimate consequences of AMC for years. I have my doubts about anything that might be a front for corporate greenwashing as a matter of principle on first contact until proven otherwise. Meaning, if there is sufficient bucks to be made via war profiteering by supplying the EU with Clean-Blackrocks, so nobody has to sleep with cold toes or whither with heat stroke, I’d expect Mr Blackrock’s fingerprint smudges will be discovered on the evidence soon enough. Anyway, I suppose that qualified as a digression of sorts. So is AMC going to act as Market ballast for you and me, as AMC employees and management, and others in the AMC ‘ecosystem’, such as Morningstar, would have us, in the Land of the Fee, believe? Unlikely if we’re not pension funds is what I gathered. Could be wrong, and these look like they may well be the kind of Times to do the stress testing necessary to find the answers.
Where to park?
I agree that there’s a tsunami of cash sloshing around. Real estate while elevated seems relatively safe but it’s also not liquid.
My main themes are, the markets are broken and that after the pandemic, people will be resilient and not prone to panic because of risk.
I occasionally look at a ratio to understand where things are, and what it’s telling me, is that things are broken, so in a way, that tsunami of cash might be exactly where it needs to be?
My guru index is:
S&P GSCI total return CME/ S&P 500
It’s median range used to be about 4.1 around 2017, it’s currently around 0.8985, which isn’t too far off from dotcom crash, or 1970’s oil crisis, but apparently the low reading indicates now is a great time to buy stocks, which is like, totally absurd. Other indexes I use also are mixed up, but generally point to b very cautious.
@oldbird probably already knows this. There is a free website with clean long-term charts, often updated daily depending on the data source, for index ratios, great for those that prefer not to roll their own, at longtermtrends.net
EN, I’m happily underweight treasuries at present but will very likely add (park) some TLT and EDV in coming days / weeks…I’ll still be underweight but see economy (and inflation) slowing down particularly with debt and demographic overhangs…
This sort of mindset at the Fed is going to needlessly hurt people. How can you admit on one hand that inflation is caused by very real supply constraints and input pressure, yet also say the solution is to suck money out of peoples pockets and put them out of work (the necessary corollary of the benign-sounding “demand destruction”)?
I’ve asked before but i’ll ask it again: if the fiscal tap has been turned off, if there’s zero prospect of Biden getting any significant spending bills passed in the next 2-6 years, where do you expect the sustained inflationary impulse to come from? Is it really better to engineer a recession just so we can say “look, now you only have to pay $2/gal on your way to the soup kitchen”?
I don’t understand the fixation on reverting to a price-stability-primacy model of the Fed’s mandate as soon as inflation runs slightly hot for a few months due to exogenous real-world problems.
What is the theory that runaway inflation is inevitable at this point? Where is all of that money going to come from? Are we expecting massive gains in the euro or the rmb? Is everyone going to flee treasuries for… tankers filled with oil? I mean seriously what is the theory?
@Jon you got a lot going there. So I’m going to just toss this out real quick for consideration. Homo saps actually don’t have as good an understanding of Inflation as they’d like you (or themselves) to believe. Except in relatively rare cases where debtor nations purposely engineer it, where can we point to damaging occurrences of run away inflation that policy makers or central bankers wanted? No where of course. No sane actors want uncontrolled inflation beyond whatever they delude themselves into thinking is an appropriate ‘natural rate’ (today’s term of art I guess)! Yet inflation happens! Over and over and over again throughout history. The professed absolute & certain causes of excessive bouts of inflation are almost exclusively the domain of backward looking theorists occupying armchairs equipped with rearview mirrors suitable for an 18-wheeler. Remember that when I or anyone else starts soapboxing about inflation.
My opinion based on seventy years of observation: Inflation is a weapon that gets deployed when the western oligarchs want to ‘make an economy bleed’. Energy is the most effective gun powder but oligarch controlled utilities, such as food and water distribution systems, work well too. Inflation always becomes an issue during progressive administrations and recedes, in importance if not in fact, when the right wing oligarchs regain control.
I mean, I feel like I’m not making a big ask here. Inflation is by definition too much money chasing too few goods. So, what’s the theory behind the suggestions that if the Fed does nothing, that inflation in the Fall will be 10%? Then 15%, 20%, etc as seems to be the commonly trotted-out rhetoric these days? Why is this just assumed to be a fact without anyone trotting out a viable theory of what’s going to cause it? If you’re going to hang your hat on some trope about, say, the velocity of money, then at least say so, so I can gauge just how many clothes the emperor is wearing.
There seems to be an increasing clamor for Volcker to rise from the grave, even among those with a purported sympathy for the working class, which seems like it demands more of a justification than “this is what we’ve always done.”
Inflation is by definition too much money chasing too few goods only in the grand manual of obfuscation. In reality, inflation is a measure of the rate of rising prices of goods and services in an economy. Since most goods and services require an energy input, energy cost can be used to manipulate inflation and its sister deflation. If the goal is to impede a progressive movement, raise interest rates or subject a society to austerity for the 95%; finding a “reason” to inflate energy costs is a good start. Wars, both foreign and domestic, work well too.
Prior to Putin’s murderous crimes against all things living in Ukraine I (my crystal ball) had the FOMC getting to 100 basis points, now I think they’ll maybe get 50 to 75 prior to the Jackson Hole pause with resumption in 2023…I also see inflation coming down significantly mid year or so…
All the commodity futures (CL, TTF, HG, PL, etc) are rapidly giving up their recent spikes.
@jyl: “giving up … recent spikes”, possibly supporting a fleeting conviction (and aren’t all convictions fleeting these days) that demand destruction is in the works, one way or another! What the price lines in isolation are usually kind of cryptic about is which of the possible drivers @H mentions above is the prime mover … whatever portion of the moves are proprietary algo driven will never have an assignable rational or valid reason … but that won’t stop the financial media from making something up if need be to supply their need, not our need, for narrative reasons …
Gute Nacht!
“Demand destruction” should take more than a few days of oil at $120 before sinking down to $98, no?
This up-and-back move in multiple commodities, lasting barely a twinkling of an eye, is confusing to me.
The oil mega-bulls on my Twitter feed seem at a loss for words, or momentarily silent anyway.
The entire world, except for a few lonely bush tribes in Africa and a few lonelier oil bears in New Jersey, knows that oil and other commodities have kicked off a mega-cycle that can only end with oil at $200/bbl, suburbs in full “Mad Max”, and Greta Thunberg begging Standard Oil to turn on the taps. Or something like that …
This move isn’t fitting the storyline. Are we missing something?