Here’s something you don’t hear every day: A cautious take on bonds from Hoisington.
Visiting the firm’s website is a bit like time traveling back to the 90s. It’s often difficult to discern when, precisely, their latest quarterly reviews are posted, but as far as I can tell, the Q1 update was uploaded on Thursday. In it, Hoisington called US monetary policy a “disaster.”
“In the face of an unsurpassed breakdown in product delivery systems, money creation caused a massive imbalance between the demand and supply of goods,” the firm said, before warning on the “harm of favoring employment over inflation.”
Not surprisingly, negative real wage growth received quite a bit of negative attention. “116.2 million American wage and salary workers suffered a 3.7% decline in their inflation-adjusted paychecks, the largest drop since 1980,” Hoisington sighed. The familiar figure (below) illustrates the point.
Hoisington also noted that although Americans covered by Social Security enjoyed a cost of living adjustment, the majority of private pensioners aren’t so lucky.
If one adds the 116.2 million Americans mentioned above to the 50 million Hoisington estimates for private pensioners not receiving a COLA, you’re left to ponder the decidedly unfortunate prospect that some 170 million people have suffered a “substantial fall in their standard of living over the past twelve months,” to quote the letter, which included a brutally utilitarian assessment of the Fed’s pursuit of the dual mandate in the pandemic era. To wit:
When this circumstance is compared with the accomplishment of the objective by monetary and fiscal authorities to lower the unemployment rate from a recession high of 14.7% in April of 2020 to 3.6% today, the fallacy of twin mandates is abundantly clear. The lowering of the unemployment rate reflected the creation of 20.4 million new jobs. Is it a fair balance to help 20 million individuals at the expense of permanently harming 170 million?
It’s not quite that simple, I’m afraid, but when you confine yourself to five pages (as Hoisington generally does in its quarterly outlook), brevity is at a premium.
To be fair, the firm went into considerable detail, citing a veritable (and wholly predictable) who’s who of historians and academics. In the course of that somewhat dry exercise, the Fed was excoriated for “allow[ing] the dual mandate to morph into a single mandate centered on the Phillips Curve,” which Hoisington said should have lost its influence “long ago.” The firm summarized the problem as follows:
In short, by relying on the Phillips Curve, the Fed avoids developing a strategic view of its role and the complex world in which it operates. Volcker explained publicly and to the Fed staff that the Phillips Curve was unreliable and not useful. Alan Greenspan was less outspoken, but he also rejected Phillips Curve forecasts as unreliable. After Greenspan left the Fed, the staff re-established the focus on the Phillips Curve, one of the central dogmas of Keynesian economics.
From there, Hoisington focused on the expectations channel, likewise paraphrasing familiar names and arguing that because inflation expectations depend on the public’s faith in the Fed’s willingness to act as Volcker did, the idea of being patient to discern if, in fact, adjectives like “transitory” apply, is a kind of logical fallacy.
The letter included a brief history lesson — essentially a retelling of the 60s and 70s — in the service of proving that “failure to knock out inflation may achieve better short run economic performance but a terrible longer-term loss.”
As you can imagine based on everything said above, Hoisington believes the Fed has little choice but to favor the inflation fight at the possible expense of lost jobs.
“Considering the historical record of imbalance where millions of people are affected by either higher inflation or higher unemployment, the Fed has no choice but to allow the unemployment rate to rise,” the firm said, adding that “higher unemployment, while harmful to some, would benefit many more millions, if inflation is contained.” Once real wage growth is positive again, the economy can reaccelerate. Or at least that’s the idea.
Ultimately, Hoisington sees a half-dozen recession “harbingers,” including falling per capita real disposable income, tremors in rate-sensitive corners of the market, rising inventories, fiscal drag and falling small business optimism (figure below).
Of course, a recession could be bullish for long-end bonds, and as bond bulls go, they don’t get much more steadfast than Hoisington.
That said, Treasurys are experiencing an existential crisis of sorts. Q1 2022 may go down as the quarter during which the four-decade bond bull market finally perished. Indeed, the trend line is in serious jeopardy and a breach of the long-term disinflationary channel in 10-year yields is among the most talked about topics amid the selloff.
But Hoisington said recession canaries “constitute a favorable environment for long-term bond investors.” Their assessment came with a rare note of caution. “However, should the Federal Reserve cease in their efforts to calm inflation before it has been fully restrained, bond investors should be wary,” the firm said.
I can’t quarrel with much of their analysis, but can certainly object to the value judgement they cavalierly toss out:
Hoisington suggests that the estimated 170 million who have experienced a “substantial fall in their standard of living over the past twelve months” is far more important than a (measly?) 20 million jobs. But, how many times worse is the complete loss of income compared to a 3.7% decline in real income? Hmm….not sure but I think the math says that 20mm x 100% = 20mm is a much bigger number than 170mm x .037 = 6.29mm, no? And that’s just pure math, giving no consideration to what part of the demographic is hurt most. A substantial part of those 170 million can tolerate a 3.7% decline (some of the more fortunate among us may hardly notice); but how big of a difference does most of the 20 million jobs created make?
Just asking….
Totally agree. The value of money is greater for the individuals who have less of it.
The value judgement is myopic at best, disingenuous at worst. He might just be angry his all-bonds funds are tanking.
Another point I don’t hear people make is that all nations decided to print money at the same time. Those who printed less aren’t recovering as well. Had the US chosen to not print as much, inflation around the world would be as bad as it is now, but Europe would be better off relative to us. I would argue we should have printed more!
I actually thought (mild) Inflation is the point of Effective Capitalism: it encourages debt to finance growth and innovation (and active work and value creation) and it penalizes just sitting on a pile of cash.
(avoiding the false morality that “saving is good” and so inflation punishes savers)…
It seems to me the Fed is always most scared of it’s most powerful constituents (those with big piles of cash) so they will prefer a Recession to Inflation.
To agree in a very long way with Kevin: saying “inflation hurts the working and poor” is a strawman because for workers every economic challenge is bad: recession, reduced hours, health issue, etc
Inflation (non-hyper) is annoying but Workers have to go to work every day and eventually get raises. In fact if they have any debt inflation will help over time.
By contrast if you have a Billion dollars and there’s a recession then there might be a paper loss but there’s also a good chance of picking up assets on the cheap (from those workers who lost a job and can’t afford their home)… so static wealth can still grow.
Now when a Billionaire contemplates inflation then everything becoming 10% more expensive (if their assets don’t inflate – like they have so much money they have a ton of T Bills) can mean yachts, mansions, etc are all actually more out of their reach!
I wonder if the US Govt, having created vast debt with long expensive wars in Afghanistan and Iraq, is maybe on the whole benefiting from inflation?
I would assume a number of assets appreciated 10%+ due to that period of money creation. That would benefit even the strictest fixed incomes of the 100million to balance a 3.7% increase which would include housing, where retirees hopefully have settled in or are on the landlord side of pricing.
In one month in early 2020, 20% of Americans lost their jobs. The same happened worldwide. We were on our way to another Great Depression.
There was no time to finely calibrate fiscal and monetary policy to do “just enough” to avert calamity but “not so much” as to unleash inflation. I question if such a delicate balance was even possible, because the tools are inherently crude. We all know that the Fed can only pump liquidity into the markets, with no way to direct what that liquidity does. We should also remember how the Federal and state govts struggled to get pandemic assistance to households and businesses (in my state, the unemployment system broke down chaotically and people waited many months before seeing any money at all). How, in 2020, could the govt possibly have gotten households just enough money to eat and stay housed, while preventing any spillover to consumer goods?
We are in the current inflationary boat because it is a lot better than being at the bottom of the ocean. And let’s be honest, for many households, current inflation is merely irritating. Personally I can’t say it has had any material effect on me at all. Suppose unemployment today were 20% and SP500 at 2000. Obviously that would be far worse for just about everyone.
Great Depression, averted, good job. Now let’s put out the inflation. Sure, we may get a recession and a bear market. The recession part will probably be mild. The bear market part – well, there are various SP500 targets out there, but even the more pessimistic ones still imply solid 3 year investment gains.
I think about the personal challenges that come with unemployment and putting the Depression in Great. We will see if social security holds up and how people losing over a year of their 35 year benefit average ends up, especially considering they were during the “best economy in history.”
That won’t be easy to replace in normal circumstances let alone having 0 income again from a recession nullifying whatever “wage spiral” boon.
jyl… my only caveat to your well reasoned and balanced statement is that Powell recently testified to Congress that the FOMC realized inflation was no longer transitory in August 2021 yet they inexplicably kept the QE spigots open…I’m still not sure whether Powell realized the damning self incrimination of that testimony …
I was sitting at the cigar store the other day and a judge was pontificating about how he gets no money from his bank account. I mentioned that people have been pushed out the risk curve.
Later I came to think about the fact that before FDIC insurance, every where you put your money was risky.
We averted a depression. I haven’t been able to stomach listening to people my age that are very well off complaining about inflation when in fact young people feel a huge affect. Any idiot my age who thinks we would never have inflation again has got to be kidding.