Zoltan Pozsar has a subtle suggestion for those attempting to forecast inflation: Consider the possibility that the shocks emanating from an epochal macro realignment precipitated by aggressive geostrategic jostling aren’t over.
In a sweeping new note welcoming investors to the “war economy,” Pozsar employed what felt like gentle condescension.
“As you focus on the contribution of used car prices, owners’ equivalent rent and Target’s inventory hangover to forecast the next CPI print and what the Fed will do next, please consider that the unfolding economic war between great powers is stochastic and not linear,” he wrote. “What inflation will do in the future does not only depend on the shocks that occurred in the recent past, but also on the many shocks that can happen still, includ[ing] more sanctions and the further weaponization of commodities, and more technology sanctions and further supply chain issues for cheap goods.”
He’s not wrong. And as is his wont, Pozsar struck a nerve. Investors habitually mistake amorphous aphorisms that could just as easily apply to sports or even crossing the street, for sage advice. In fact, some such aphorisms originated outside of the market context — “skate ahead of the puck” is one famous example. In many cases, those tired, nebulous adages emanate from purported “legends” of the macro investing pantheon. Skating ahead of the proverbial puck in 2022 generally means adopting a “contrarian” view that inflation will recede more quickly than many expect based on a bevy of assumptions about commodity prices, retailer discounting and “healthy” demand destruction.
Pozsar sees a problem with some of that in the current context. “Macro investing had its golden age in the post-Cold War era, and investors like George Soros, Stanley Druckenmiller, Paul Tudor Jones, and Louis Bacon traded in a peaceful world, punctuated only by relatively small military conflicts,” he wrote.
To the extent such traders encountered major conflicts, they “involved markets and central banks” and thereby par, interest and FX. If you’ve read enough Pozsar (and particularly Pozsar outside of his “dispatches” for Credit Suisse) you’re familiar with the four prices of money. Today, investors face a more daunting task — namely, “a complex economic war between ’empires,’ driv[ing] the fourth price of money: The price level and its derivative, inflation.”
And it isn’t only investors who are vexed. Central banks are used to protecting par, defending pegs and closing bases in rates. What’s at stake now are price levels for real world goods and services.
I criticized a few of Pozsar’s missives published early in the Ukraine conflict for a variety of reasons I think are well founded. In April, Rabobank’s Michael Every penned a lengthy critique of the same missives, hitting many of the same notes. But Pozsar’s latest delivers, and I’ll be the first to admit that one reason I find it palatable is because it aligns quite well with much of what I’ve written on the same subjects this year. (I should clarify: I’m not suggesting Pozsar read, or would even care to read, what I’ve written about inflation or anything else. I’m merely saying the way in which he addresses several key issues is consistent with the way I’ve approached the same subject matter.)
Pozsar called our current predicament “mostly a story about the ‘revenge’ of headline inflation” which, in turn, is mostly attributable to the war in Ukraine. Then, using far fewer words than I have (and it says a lot about my total disregard for brevity when Zoltan is more concise), he explained why it is that the risk of a wage-price spiral is more acute now than it would be under a high-inflation regime not driven by necessities.
“After decades of neglect, food and energy prices can’t be stripped out to focus only on core inflation,” he said. “Food and energy prices — basic, everyday necessities — are especially dangerous in a structurally tight labor market, as workers demand higher wages not when discretionary items like TV screens and cars cost more, but when necessities cost more.”
I couldn’t have said it better myself and, as alluded to above, I didn’t say it better myself, I just said it using (far) more words. When real wages are deeply negative (figure on the left, below) in an environment of high inflation for necessities (figure on the right), workers won’t just ask for raises, they’ll demand them because eating and keeping cool/warm aren’t optional.
As a reminder, the latest ECI data, released last week, showed inflation-adjusted wages for private industry workers fell the second most ever during the three-month period from April to June.
Pozsar dismissed fiscal stimulus in the US (almost out of hand) as something worth discussing. “We have purposefully omitted the contribution of stimulus measures from our discussion about the nature of today’s inflation,” he wrote. “While generous stimulus checks in the US have no doubt contributed to elevated rates of inflation, inflation is elevated everywhere, including in countries where stimulus was less generous.”
On that score, at least, Pozsar appears to agree with Joe Biden, who has repeatedly implored someone (anyone, anywhere) to explain why, if his stimulus package is the proximate cause of inflation (as opposed to a secondary contributing factor), inflation is elevated in every major industrialized country on the planet. Even Japan now has above-target inflation.
Much to my delight, Pozsar also declared economic forecasting fruitless, a point I’ve hammered home in these pages, likely costing myself several arm’s length friends in the process. He described a conversation with a “relatively junior member” of Credit Suisse’s econ team (and that must’ve been amusing — “I don’t think we’ve met. I’m Zoltan. Got a minute?”) who called the forecasting environment “humbling.” Pozsar posed a question to readers based on that chat:
Now, if an economist straight out of university gets that in a stochastic world — where the price of everything is thrown around randomly by a pandemic and an unrestricted economic war — inflation is impossible to forecast, why is the market so confident that inflation is about to peak?
At that point, a half-dozen pages in, Pozsar was in the zone. When he finds that pocket, he’s brilliant, although he never eschews an opportunity to name-drop people he knows but you don’t, a habit that comes across as either childlike or arrogant depending on how self-assured the reader happens to be (I’m very self-assured).
“Some market participants like to see the silver lining in today’s environment, arguing that energy prices today aren’t as big a deal as they were in the 1970s, because a service-intensive economy is less energy intensive,” Zoltan wrote, before immediately dispensing with that argument as “nonsense” by way of (another obsequious) Bill Dudley shout-out:
What oil is to an industrial economy, people are to a service economy, and when Bill Dudley says that in his forty-year career in finance he hasn’t seen a labor market this tight, I assume he means that the service economy is having its “OPEC moment.” I can’t have a client meeting without someone asking me where all the workers have gone. I have no idea, but they are apparently gone, and after a while, it becomes pointless to wait for Godot.
After that, Pozsar nodded to Ray Dalio and Larry Fink, two other luminaries who, as far as I’m aware, he doesn’t know as well as he knows Dudley, who came up five times in 10 pages.
If Dalio and Fink are correct that the US is headed for (or is already suffering from) stagflation, then slower economic growth may not be sufficient to tame price growth. Paul Volcker (who, I assume, Pozsar hasn’t spoken to this year), wasn’t solely responsible for vanquishing inflation, Zoltan reminded investors. He had help.
“Major energy companies had poured billions into new energy projects” and new oil fields were developed both at home and abroad, Pozsar recalled. Additionally, the power of unions began to decline and with it, “the institutional practice of linking wage increases to the rate of inflation ended,” he wrote, on the way to noting that things “couldn’t be more different” in 2022.
Today, by contrast, investment in fossil fuels is hamstrung by climate initiatives and if there’s one takeaway from the copious number of sell-side energy dailies that land in my inbox, it’s that the market remains extremely tight irrespective of recent price declines engendered by recession fears. “The oil market will get tighter during the Fed’s current tightening campaign, not looser like under Volcker,” Pozsar wrote.
Additionally, Pozsar claimed Volcker had it relatively easy when it comes to short circuiting the wage-price spiral. The “political will” to break labor as an economic actor did a lot of the work. In 2022, the US labor market is “a mess,” as Zoltan put it, citing immigration policies aimed at “appeasing nativists” and early retirements facilitated by a $40 trillion post-pandemic wealth bonanza (figure below) which is working on both sides of the equation by removing workers early and straining the capacity of the services sector where those retirees spend their money.
Household wealth fell a bit during the first quarter, but a $1.7 trillion gain in the value of property helped offset a $3 trillion decline in the value of equities. The small drop scarcely made a dent in the mountain of gains, paper or otherwise, which accrued to Americans fortunate enough to own a home and stocks in the post-pandemic era.
Pozsar also noted that it’s hard to “grow people.” “Even in The Matrix, that’s possible only over time,” he quipped, adding that “until then, we are stuck with a labor shortage, and President Biden’s top labor lawyer is the anti-Reagan: She’s encouraging the unionization of workers from Amazon to Starbucks as opposed to firing them.”
Ultimately, Zoltan said that between all of the above, he’s having a very difficult time understanding why inflation can’t go higher, although he conceded, caustically, that “Maybe it’s because I do not have a PhD degree.” (Pozsar is, allegedly, smarter than every PhD with whom he’s ever shared a meeting room.)
In “America Needs To Rediscover Sacrifice In Inflation Fight,” I wrote the following:
As bleak as this most assuredly is, the Fed needs to crimp demand for inelastic goods and services. That’s not what [The White House] means when they say the Fed has the tools it needs, but in reality, that’s the only thing such statements can mean if they’re supposed to be true. The Fed needs to tell the public that it intends to hike rates such that jobs are lost and such that the accompanying economic pain materially reduces demand for necessities. After all, the rise in inflation is in no small part a function of rising prices for those necessities, and if the Fed can’t conjure fuel, food and houses, then how else can they address the problem?
In his latest, Pozsar echoed that — and then some.
“If Jay Powell is engaged in the ‘general mobilization’ of Paul Volcker’s legacy, he also needs to engage in a ‘general mobilization’ of US consumers to spend much, much less,” he wrote, adding that,
‘[G]eneral mobilization’ in the US means a recession. A big, long-lasting one to purge the ‘Super Size Me’ mentality and replace it with Jimmy Carter’s theme of living thriftily. And that involves not only slowing the interest-rate sensitive parts of the economy (housing and durables) but also reducing demand for labor in the service sector, which, as we have argued, is a function of the level of wealth across a range of assets (housing, stocks, as well as crypto) to weed the “feel rich, spend more” and “feel rich, work less” mentality from the system. And what the Fed is telling us when it flat-out dismisses two quarters of negative GDP growth is that it isn’t focusing as much on the rate-sensitive parts of the economy as it did in the past. Instead, it is focusing much more on the services economy and the labor market, which still remain strong. And therein lies the cautionary tale for the market, which expects the Fed to “chicken out” about growth in its fight against inflation. Basically, this is one reason why the market expects the Fed to ease in a year’s time. The other is the wishful thinking that inflation has peaked.
No one wants to hear any of that, of course. And the Fed would never say it out loud, or at least not the part about thrifty living. Americans feel like they’re entitled. To everything. Houses and cars they can’t afford, vacations they don’t need if gas prices are prohibitive, a third or fourth or fifth flatscreen, dinner portions that are quintuple the recommended serving size and on and on.
That sense of entitlement, more than anything else, may ultimately constrain the Fed. Pozsar repeatedly emphasized that Powell is accountable to Congress, but really, he and Congress are accountable to the public. In an extreme scenario where 300 million Americans insist on their solemn right to drive tank-sized SUVs into the McDonald’s drive-through with the air conditioning cranked down to 62 while they wait on a worker making $9/hour to serve them 8,000 calories for $4, then that’s just what they’ll do because… well, because there aren’t enough troops. I’ll just leave that there. Or leave it for another day.
Pozsar’s warning for investors was straightforward enough. “This is not the growth-sensitive Fed of the post-GFC era. This is not the stocks-sensitive Fed of the post-Greenspan era. This is not the unipolar world order the Fed’s been operating in since WWII,” he cautioned. “If you think that the peak of tightening is 3.5% because inflation peaked, (maybe it hasn’t) and that cuts are coming next year because a recession is nigh and stocks are now at the cusp of a bear market (maybe not, because we need a recession, and lower asset prices are the path to a recession), you might be terribly wrong.”
Eventually, Zoltan got around to asking (himself) if he might be missing something. The short answer is “no.” No, Pozsar doesn’t think he’s missing anything. Pozsar and “missing something” is a contradiction. Or at least that’s how he and (too) many market observers are inclined to think while exalting his missives which, over the years, have undergone a total metamorphosis from impenetrable, esoteric arcana to outright page-turners.
In true page-turner fashion, Zoltan closed with a flourish. “Is Jay Powell a dark horse who is more political than serious about inflation?” he wondered. Pozsar doesn’t think so. The history books, he suggested, won’t remember Powell for giving up. “Once you go down the path of invoking Paul Volcker’s legacy, you can’t avoid making good on that promise: If you do, you damage the Fed’s reputation irreparably.”
Success isn’t assured given the nature of inflation in 2022 and the backdrop, defined as it is by economic war. But it’s not a question of success of failure, Pozsar wrote. Instead, it’s a question of whether Powell is willing to risk it all in the fight to rescue America from inflation.
“There I have no doubts,” Zoltan said. “The risks are such that Powell will try his very best to curb inflation, even at the cost of a ‘depression.'”