Stubborn US Economy Won’t Go Gentle Into That Good Night

Every day it’s the same story. Or, rather, the same question: Is good news bad news and vice versa?

For years, markets operated on some version of that paradox. Bad news was good news because it gave central banks plausible deniability to persist in accommodation in a disinflationary environment. Good news was bad news because it raised the odds of incrementally less accommodative monetary policy.

In 2022, that framework no longer works. To lapse briefly into the colloquial: Inflation screwed it up. As I put it in “Why The Bear Market Will Resume,” the Fed isn’t operating in growth-conscious mode. They’re operating under what amounts to a single mandate where the inflation fight takes precedence over all other concerns.

Until inflation recedes, bad news is just bad news. Even worse, there’s a very real sense in which the Fed wants bad news, and wants to be sure it’s interpreted as such by markets. Although they won’t say this explicitly, part and parcel of the fight to wrestle down inflation involves engineering a reverse wealth effect, whereby stocks drop and home price appreciation cools. When stocks rise, it’s counterproductive on two fronts: It eases financial conditions when they need to tighten and it makes people richer when they need to be poorer. I realize that reads like something out of The Onion, but that’s the world we live in.

It’s through that lens that all incoming economic data needs to be interpreted. Economic data like Monday’s better-than-expected durable goods print. Orders rose 0.7% in May, easily better than expected (figure below) and far enough ahead of consensus to offset a slight downward revision to April’s figures.

The core prints (i.e., both orders and shipments) were solid. Business investment is fine, apparently.

That sounds like a positive development, and if you think recent PMI softening needed an “offset,” as it were, I suppose it is. But ultimately, the economy needs to cool, not plow ahead. We’re trying to engineer a recession here, after all, and these kinds of prints won’t get us there.

“This may offer some near-term comfort that capex is hanging in there, though it’s an open debate for how ‘comfortable’ than conclusion actually is,” Bloomberg’s Cameron Crise wrote Monday. “If it provides confidence to the Fed that its relatively sanguine prognosis for near-term economic output remains accurate, that suggests less prospect of policy capitulation and perhaps a greater risk that they will view a further easing of financial conditions via an equity rally as unwelcome,” he added.

Also unwelcome in that context was a better-than-expected read on pending home sales, which actually rose in May (figure below). The 0.7% advance was set against expectations for a 4% decline and came one business day after a solid read on new home sales.

It was the first gain in seven months. On a 12-month basis, sales fell 13.6%.

NAR Chief Economist Lawrence Yun adopted a cautious cadence. “Despite the small gain from the prior month, the housing market is clearly undergoing a transition,” he said Monday, flagging the fairly dramatic YoY decline in the face of sharply higher borrowing costs, which have essentially doubled in a very short period.

Yun suggested the Fed’s approach is suboptimal. “Trying to balance the housing market by choking off demand via higher mortgage rates is damaging to consumers and the economy,” he said. “The better way to balance the market is through increased supply, which also helps the broader economy.”

That’s unequivocally correct. But as discussed at some length in “Inflation Blame Game: Whose Fault Is This Really?” supply factors have to be addressed in the political arena, whether that means incentivizing domestic production of goods that are suddenly harder to get from overseas, rethinking the green transition strategy in the name of expediency or negotiating a ceasefire in a foreign war.

If politicians don’t do their part to address supply factors, it’s left to the Fed to lean even harder into demand. The longer it takes for economic variables to respond to those efforts, the harder monetary policy has to push. Eventually, if the economy refuses to respond, the Fed will have to start shoving in order to engineer better inflation outcomes. Until then, good news is bad news.

In the short post quoted above, Bloomberg’s Crise alluded to a gentler version of my admittedly caustic take. As long as the economy continues to perform in a way that suggests resilience, the more deaf the Fed will be to any shrill cries from equities during selloffs. As for stock rallies, good data is carte blanche for the Fed to take a hostile approach to higher stock prices. Everything is expendable in the inflation fight, but nothing more so than equities.