The odds of a “left-tail,” hard landing scenario for the US economy have “exploded higher.”
That’s according to Nomura’s Charlie McElligott, although it might be more apt to say it’s according to markets.
Terminal rate pricing moved up some 40bps over just 24 hours (figure below), as markets struggled to quantify the policy implications of a huge upside surprise in monthly core CPI.
At this point, the Fed is condemned to hike until it breaks, where “it” means the domestic economy, yes, but also stocks. And the housing market. And everyone else’s currency. And emerging markets in general.
“A ‘hike until it breaks’ accident is now the most likely outcome,” McElligott said, adding that when taken in conjunction with extremely hot nominal wage growth, the “shock re-acceleration” in the MoM core CPI prints “hints disturbingly” at a worst-case scenario for the Fed, characterized by entrenched inflation and a wage-price spiral.
It’s becoming harder by the month (by the week, even) to dispense with the notion that inflation in advanced economies has likely reset permanently. That doesn’t mean headline annual price growth will run at 8% in perpetuity, but it may mean that core prices don’t reach 2% again for the foreseeable future.
Note that the Cleveland Fed’s outlier-omitting gauges both moved up markedly in August (figure below).
Those indexes, you’re reminded, are designed to capture “the interior of the distribution of price changes” in order to “provide a better signal of the underlying inflation trend” compared to headline and core CPI. Suffice to say the trend isn’t your friend.
Moreover, the bank’s inflation “nowcast” showed core CPI for September was forecasted 0.5% higher on a MoM basis as of Wednesday, while the 12-month nowcast for core was projected at 6.64% as of September 14.
The market seems to understand how bad this is. Or, at the least, that the Fed is inclined to believe it’s bad, which is enough. All day Tuesday, I reiterated that the read-through for the dollar and US reals was very challenging for risk. On Wednesday, McElligott didn’t mince words. The soaring dollar and rising reals are “pure poison for risk assets,” he wrote, adding that surging real yields represent “a rate-of-change shock in the cost of capital [which] risks slamming the brakes on the US economy via punitive borrowing costs on both corporates and consumers, which spills over into lower demand for goods and services.”
Unfortunately, that may be the only way out for the Fed now. Not to put too fine a point on it, but this is precisely what the likes of Bill Dudley tried desperately to warn Jerome Powell about.
“This intentional ‘crash landing’ of the economy has seemingly become the lone path left for the Fed in order to kill the demand side of their inflation problem, which likely necessitates a recession going hand-in-hand with a markedly higher US unemployment rate,” McElligott sighed. “And it seems clear now that the market gets the joke.”
Fed QT 2022 or: how I learned to stop worrying and love the credit bomb
Starting to feel like a 20-25% market correction is the only thing that will get Powell’s attention, and perhaps the “sure-firest” path for “policy” to actually engineer demand destruction without taking the whole economy with it. While I acknowledge that the market is not the economy and is concentrated among wealth hoarders rather than everyday spenders, it sure seems to me that the everyday spenders feel connected to the market, even if in practice it is only through their 5-figure 401(k)s or disappearing crypto wallets.
I’m still in the camp that something is going to break — it’s not clear to me that ample dry powder or light positioning can overcome persistent illiquidity, and we’ve barely scratched the surface on defaults and credit deterioration. Bring on the rail strike, election and Trump indictments!
Some good points there Furious One.
My nomination for the blow up is over in the private equity space. Massive inflows, smug holders, horrible liquidity (except for window dressing transactions between managers to prop up reported deal prices.) Cue up “Flirting With Disaster” by Molly Hatchet.
With all due respect, I don’t think it’s a question of the markets getting Powell’s attention; the markets need to unclog their ears and listen to what Powell is telling them: we, the Fed, are going to get inflation under control and if the value of your home on Zillow or the balance in your portfolios suffer, well, that’s capitalism.
I agree with you mfn. My point was trying to be the flip (reverse, not funny) side of what you’ve said. Inflation’s gonna do what inflation’s gonna do, and Powell will answer as the Fed deems appropriate with interest rates. But the market continuing to sell at plus multiples and buoyed by massive buybacks when macro fundamentals have changed so dramatically (multiple inversions, elevated MOVE, 1% reals, energy shortages, war, plague, even our expensively lethal climate), says to Powell that we are not listening and thus working counter (re loosening financial conditions) to his dubious effort to stick the landing. But 2018 showed us he seems to be a lot more observant when it comes to stock index levels than he does sometimes with indicators in the larger economy. So I think he will continue to bring the pain until we figure out where the secret new Fed put is. I’m pretty sure it’s not SPX 3600. Black swans aside, I’ll guess 2800 in a (hopefully) momentary panic. And I don’t think that would hurt the subsistence consumers getting killed by inflation much, but it might give a little religion to the more discretionary consumers with their 5-figure 401(k)s all the way up to 8- or 9-figure trusts, especially if the market goes down and stays down a while. Tighter financial conditions and less frothy spending takes some of the pressure off Powell and his interest rate hammer, which I fear may be a proximate cause of something breaking via the dollar. A lower stock market puts the pain on those who can bear it most. The question is whether Powell will abide with that. History says no, but that was before he started having to drive by homeless camps on his way to work. (And I am not singling out Powell, just shorthand for Fed).
the only hope I currently see involves the takedown of Putin, preferably from the inside to minimize further inhumane horrors…fuel and food price decreases would fuel worldwide relief…unfortunately this is not my base case…
Also let’s not forget there is a domestic political party which openly prefers a dramatic crash of some sort in order to make the current administration look weak.
Mr H, As Ur previous excellent articles have perhaps suggested: How much unemployment is required to create enough demand destruction to prevent further rising of food and rental inflation… which as of yesterday’s report are yet to be tempered. And will decimating the S&P another 15-20% motivate the top 10% who own 90% of equities to order a smaller bucket of chicken at KFC or buy the cheaper store brand baguette ? And what does demand destruction in food and rent actually look like ?? More homeless people who can’t afford rent ?? Less food consumed by the soon to be unemployed ?? Perhaps we need to revise how core CPI is calculated so the excessses of fiscal and monetary largesse (I will assiduously avoid MMT due to the grave risk of being mercilessly berated 🙂 are not eventually corrected by reducing the living standard of workers in the bottom half of the socioeconomic scale.
I still think people are clinging so hard to the interest rate numbers that they continue to overlook that QT is doubling to $95B this month where it will stay until “…balances are somewhat above the level it judges to be consistent with ample reserves”. They aren’t very transparent on what “ample reserves” are so the QT could continue for quite some time. It seems to me that raising interest rates primarily affects borrowers whereas QT directly sucks money out of the markets. Maybe it is an overly simplistic view…