It’s probably not wise to make too much of Q4’s earliest price action. Equities were coming off an egregious September and although angst is pervasive, some enterprising optimists surely see an oversold market.
At the same time, it’s fair to suggest Fed officials are starting to think seriously about downshifting to 50bps rate hike increments. It could very well be that by the time the next policy meeting rolls around, the risk-reward asymmetry favors half-point moves.
It’s not obvious what you gain in the domestic inflation battle by moving in 75bps strides now, after three consecutive such steps, versus a 50bps cadence. By contrast, it’s becoming more obvious by the day what you lose by pretending the rest of the world doesn’t exist or that the US economy and financial system are somehow immune to the boomerang effect from messy spillovers.
Make no mistake, the damage is already quite pronounced. The entire G10 FX complex is at risk (to a greater or lesser degree), and if you prefer a 30,000-foot view, complete with flashy sums, note that the total losses for global stocks and bonds are staggering.
“Through 2020 and 2021, global bond and equity market capitalization surged from $125 trillion to over $160 trillion [but] in just nine months, those outsized gains have been wiped out,” SocGen’s Andrew Lapthorne wrote Monday. “Bursting bubbles have long-term damaging consequences for the financial system and a $35 trillion decline is going to hurt.”
Yes, indeed. The ongoing malaise is compelling even the Street’s more bullish strategists to rethink targets. On Monday, Credit Suisse’s Jonathan Golub cut his 2022 S&P price target to 3,850 from 4,300, and initiated a 2023 target of 4,050. Believe it or not, that still counts as a reasonably optimistic outlook. Still, Golub sees index-level EPS growth of just 1.3% next year.
For Rabobank’s Philip Marey, a “double” US recession seems like a foregone conclusion (the scare quotes are there as a reminder that virtually no one believes the NBER will retroactively declare Q1/Q2 2022 an official recession, despite two straight negative real GDP prints).
“Unfortunately, once the technical recession is in the rear view mirror, we are heading for an NBER-stamped recession, probably next year,” Marey wrote. “The economy is still getting hit by supply shocks, high and persistent inflation and tighter monetary policy and it is only a matter of time before businesses slow hiring,” he added, before suggesting a real downturn may be necessary to stifle inflation. “A recession seems inevitable: Even if the US is able to absorb the exogenous shocks to the supply side of the economy, the response of the central bank to the wage-price spiral will cause a recession from within,” he said.
Part and parcel of all this is the (now consensus) notion that this time isn’t different after all. Fed tightening cycles end in tears, and this one will too. There’s already weeping aplenty overseas, and the US economy will be choked up soon enough.
Marey wasn’t the only one to speak in fatalistic terms. “A Fed overshoot seems inevitable,” BofA’s Mark Cabana sighed. The Committee “is hiking at the fastest pace in recent memory while they are at max uncertainty on the macro outlook,” he wrote. “The market is going to keep pushing real rates higher and the Fed won’t stop until something breaks.”
In a note published just as the new week dawned, JonesTrading’s Mike O’Rourke said September’s deep selloff “should finally bring the market’s denial stage to an end.” Investors and traders are “correctly interpreting that there are no rate cuts on the horizon,” he wrote. “We believe the greater risk has shifted towards overtightening and the significant policy error that could be.”
RIA could have written those last lines for Mike O’Rourke!
I’ll have to fish out the CD with “Slow Motion Crash” by the Samples and give it a listen.
Let’s not forget the likely recession later in the decade as the super macro cycle of large demographic shift as the millennial household formation peaks in approximately 2027. It will be an investment environment most have never lived (at least invested) through, back to back to back recessions.
Good news is we’re likely to have a multi-decade bull market thereafter.
I truly hope nothing breaks between now and November. The Fed needs to soften its hawkish tone as soon as possible. The inflation picture won’t change much between now and the mid-terms, but if something breaks and Republicans even take one chamber of Congress, which appears likely, there won’t be any fiscal backstop if things go badly awry. It’ll be like Obama and the tea party republicans all over again, and Trump will once again ascend to the presidency.
While I completely get the 2010 comparison, This Time Is Different (HAR)!
No really. There’s a quasi-Goldilocks view I haven’t seen anyone discuss, and it dovetails with the 2010 experience in a “history rhymes” sense.
The 2010 tea party wave imposed fiscal austerity in the trough of a recession. That’s the wrong thing to do, at least within Keynsian orthodoxy. In an inflation battle, however, fiscal austerity isn’t the worst thing. Still, you want a degree of fiscal support, but you want it targeted as much as possible to things that will alleviate supply-side problems while helping those most impacted by inflation. That’s where I think we’ve actually stumbled ass-backwards into a bit of a win.
While new major spending is highly unlikely going forward thanks to a probable divided congress, a lot of spending has already been allocated, and it’s the kind which takes time to kick in. There have been 4 big (and I mean big. Seriously big.) spending bills since Biden took office:
1) The last big Covid spenduluos. This had a lot of helicopter money, which is obviously pro-inflationary. It’s done though, and at least it helped those most impacted by inflation.
2) Infrastructure Bill. This is a classic case of something which takes time to actually spend while working to ameliorate supply-side bottlenecks.
3) Chips bill. This will take years to have an impact, but the money has been allocated and it will have an impact, again supply-side.
4) Inflation Reduction Act. Just more spending, might not help inflation, but again you’ve got years of allocated stimulus which can’t be blocked by some future GOP congress.
Add it all up, and the fiscal stimulus to respond to recession is already in place. The absence of any new spending (and probably even a few government shut-downs) will help with the inflation fight. The FEDs gonna FED, so fiscal tightening will continue apace, and we could actually find ourselves in a bizarro world where we actually stick a soft-ish landing. Sure our ankles will be broken, but we survived.
Ironically (?) this is only possible because our reserve-currency status allows us to export a great deal of the inflationary impulse as the rest of the world subsidizes our rebound. Given the realities of American politics though, the set up couldn’t be much better. I’ll take it.
Yeah, those are good call outs. There is definitely more fiscal support that will work its way through the pipeline over the next couple years, and the political albatross of the ACA isn’t hanging over democrats heads. Margins of victory will certainly matter as there may be some leeway if Republicans hold a very slight advantage in the house. There are probably enough Republican reps that secretly detest the idea of Trump in the White House again that might get on board with some sort of fiscal support in the event that things go badly awry.
Investors now remind me of the pentagon, fighting the last war. Inflation is getting snuffed out. I am praying this downturn is mild. But hope is not an investment strategy. We are getting a nice technical bounce. Caveat emptor.