Fed Needs You To Believe Panic Equals Credibility

Only twice during the past 50 years have US consumers been more concerned about reduced living standards due to inflation.

That was one takeaway from the final read on University of Michigan Sentiment for March.

Not surprisingly considering the incessant barrage of dour headlines emanating from eastern Europe, the headline gauge fell slightly from the preliminary print, which already marked a decade nadir. I say “not surprisingly,” but economists were apparently surprised. Consensus expected no additional deterioration.

At 59.4, the headline was marginally lower compared to earlier this month, and the current conditions index fell slightly too.

“When asked to explain changes in their finances in their own words,” more consumers cited inflation-related erosion in their standard of living “than any other time except during the two worst recessions in the past fifty years: From March 1979 to April 1981, and from May to October 2008,” the color accompanying the survey said.

Consumers were still upbeat on the labor market, but half of all households expect their real incomes to decline over the next year.

And why shouldn’t they harbor such expectations? After all, real wage growth has been consistently negative for everyone except those at the very low-end of the pay scale (figure below).

Do note: Six of the last eight recessions were accompanied by negative real wage growth.

“True, the labor market is super-strong today,” BofA’s Michael Hartnett wrote, referencing the latest initial claims print, which was the lowest in more than a half century. “But the labor market is a lagging indicator and a weaker economy is required to reduce inflation,” he went on to write.

Try as I might, it’s very difficult to imagine the US economy surviving the Fed’s hiking cycle. It’s equally hard to believe the Committee will be successful in averting a downturn by reading the tea leaves on the way to a deft policy pivot that averts a recession. After all, the tea leaves are already saying something about the likely timing of a contraction and all “soft landing” soundbites aside, officials don’t seem to care. That indifference isn’t a product of callous disregard. Rather, with inflation this high, they can’t afford to care.

You don’t need to be a tasseographer to divine something potentially meaningful from collapsing yield curves. Friday was another ominous session in that regard. Headed into the US afternoon, the 2s10s narrowed sharply, and the 5s30s closed in on inversion (figure below).

If you think negative real wage growth has a good track record for predicting recessions, wait until you hear about the curve’s claim to supernatural prescience.

“With 10-year yields setting cycle highs on Friday while twos reached above 2.25%, our biggest takeaway remains that all roads lead to inversion,” BMO’s Ian Lyngen and Ben Jeffery said.

“Powell has clearly signaled a 50bps move in May and we’re operating under the assumption that this is accompanied by a balance sheet runoff announcement,” they added. “In short, the Fed is now in full-hawk mode.”

Yes, the Committee is in “full-hawk mode,” with the curve poised to invert and Americans staring down the biggest cost of living shock anyone under 40 has witnessed in their lives.

And therein lies the tragic irony of it all. The Fed is duty bound to act, ostensibly to tame the inflation dragon and thereby alleviate the burden of soaring prices for lower- and middle-income households who spend a higher percentage of their income on food and fuel than the wealthy. But policymakers are acutely aware of the possibility that their efforts will come to nothing given the nature of the problem.

The inflation shock is “getting worse,” BofA’s Hartnett went on to say, in his latest, citing a 26% YoY increase in German producer prices. The rate shock is getting worse too, he added, noting that central banks now expect the public (and markets) to equate panic with credibility. A big ask, to be sure.