News flow has turned almost uniformly foreboding, which I suppose could be a precursor to better days if you’re a believer in the old “darkest before the dawn” adage.
Vladimir Putin targeted Ukraine with missiles and Iranian drones for a fourth day, in a continuation of a reinvigorated air campaign. Ukraine shot down at least nine of the unmanned vehicles yesterday, and according to The New York Times, Kyiv has received “basic intelligence” about the drones (which the UK calls “slow-moving” and “easy to target”) from Israel, which knows a thing or two about Iranian weapons systems. “Ukraine has asked Israel for air defense systems as well [but] Israel has so far declined, reluctant to provoke Russia into obstructing Israeli airstrikes in Syria,” the Times said.
Ukraine has made the most of its limited air defense capabilities throughout the conflict, but Russia launched at least 100 cruise missiles and scores of drones against the country over just 48 hours this week. In addition to increasing the West’s resolve to supply Ukraine with advanced weapons, the Russian air raids prompted NATO to speed consideration of a multi-layered European air defense system. “We have to move quickly now,” German Defense Minister Christine Lambrecht said. “Quickly” is a relative term. The project, which entails stringing together Israeli Arrow 3 systems, US-made Patriots and German Iris-Ts, is just barely in the planning stages. Olaf Scholz said Putin “considers the war to be part of a larger crusade against liberal democracy.”
In response to the new airstrikes, the Biden administration is pondering a complete ban on Russian aluminum, which Bloomberg helpfully noted “would have wide-reaching repercussions, potentially forcing consumers in the US and other countries into a rush to find replacement metal.”
The good news is, Russia is only the second-largest producer. The bad news is, the largest producer is China, with which the US is now in a “full-scale bilateral economic cold war,” as one analyst put it earlier this week, after the White House stepped up export restrictions in a bid to halt Chinese efforts to develop advanced chips domestically.
The semiconductor escalation was insult to injury for an industry coping with an increasingly dire demand outlook, which is manifesting in job cuts. Intel is apparently in the process of laying off thousands of workers, and on Thursday, TSMC (a focal point in the US-China standoff) cut its capex target by 10%. That’s another (very) bad omen for demand. The shares, which plunged earlier this week (figure below), trade on an 11 multiple, down from 30x early last year.
Mercifully, the company reiterated its longer-term revenue guidance. Its margin forecast suggested any impact from the new US restrictions would be manageable. Taiwan’s economic affairs minister this week urged investors not to panic about the Biden administration’s new curbs.
Meanwhile, Fed officials continue to parrot some version of the “restrictive for longer” narrative. The September FOMC minutes contained no new information and frankly, the macro situation is so fluid that any account of a weeksold meeting isn’t just “stale,” it’s useless. Consider that since the September FOMC, Ukraine came as close to collapsing the Kerch Strait Bridge as you can reasonably be expected to come when you’re not shooting at it with cruise missiles or bombing it from the sky, and Liz Truss came as close to collapsing the UK pension system as you can reasonably be expected to come when you’re not actually trying to collapse it.
There is a subtle tone shift in the Fed rhetoric, though. It’s obvious officials are apprised of the extent to which market pleas aren’t merely the shrill lamentations of spoiled children demanding candy. Markets, rather, are ailing addicts suffering debilitating withdrawal symptoms. Note that Korea this week was forced to ratchet up the size of rate hikes out of concern for ongoing Fed tightening.
The Fed wants to get to 4.5% without a catastrophe and then sit there for a while, on the assumption that eventually, the US labor market will respond, inflation will cool and they’ll be able to claim they achieved the impossible: A soft landing from 9% headline inflation with a policy rate of just 4.5% and an unemployment rate under 5%. And all without anything “breaking” overseas.
To call that far-fetched (or wishful thinking) is an understatement. When this episode is enshrined in economics textbooks, it may be remembered as the quintessential example of “the best laid plans.”
“When this episode is enshrined in economics textbooks, it may be remembered as the quintessential example of “the best laid plans.”
And/or the final nail on the coffin of classical economic theory and maybe the end of central bank independence. Both are human constructs: neither were handed down from heaven on stone tablets nor are they immutable laws of nature.
It would be interesting to see some historical data on how fast inflation decreases once the top has been reached. My gut tells me it’s a fairly quick process although I don’t have the data to back it up. My point being that the saying “darkest before dawn” may be accurate here. It’s fairly basic economics that if people can’t afford anything else than the “basics” then demand will be destroyed and inflation will subdue in the end.
Keep your fingers crossed. Know that many items we buy regularly are considered “sticky” and don’t come down. If your landlord has raised your rent, what are the odds it will be lowered when things get back to normal? Biggest single expenditure for most folks is shelter. Some food prices will come down, but wage increases will stay so that input cost for goods and services will not go away. We all have a need to eat and stay warm and healthy. Those costs won’t go down anytime soon.
Yeah, two of the biggest contributors to inflation are housing and labor availability, and our current policies are hurting both, especially in the long run. New housing construction will dry up with higher rates and our net immigration rate has declined substantially the last 5 years. Add in early retirements from the wealth gains since the pandemic and you’ve got a recipe for sustained inflation.
We need a national housing policy and a significant increase in immigration, and neither of those are going to happen anytime soon. Instead, we’ll get a Fed that will raise rates until something breaks, at which point they’ll be forced to pivot, only to see inflation come roaring back.
Yes, and inflation does destroy demand….
If only the US Federal Reserve could send a “signal” to the fiscal side of the US government….. 🙂