If Milton Friedman was right, inflation may be poised to crater.
“[CPI] is one of the most backward-looking data series — it says very little about the future and can be misleading about present conditions,” Morgan Stanley’s Mike Wilson said.
Wilson, like inflation, is riding a hot streak. After getting the pandemic rally (mostly) correct, he was a bit early to call time on the bonanza, but not so early as to be wrong. In fact, you could argue that missing the final month (give or take) of the rally was worth it if it meant positioning preemptively for the bear market. Wilson did just that. He also explicitly predicted the accumulation of excess inventory at America’s largest retailers and although his call for a corporate profit reckoning was premature, he made up for it two weeks ago, when he said a technical rally for US stocks was probably imminent. The S&P promptly surged for two straight weeks.
That brings us to Monday, and the figure (below) which shows M2 growth leading headline CPI.
Wilson channeled Friedman. “Think back to what CPI was telling us at the end of March 2021. The index sat at 2.6% YoY after the government had delivered more than $3 trillion in fiscal stimulus,” he wrote, noting that money supply was expanding at a wholly unprecedented 27% rate.
“Given that inflation is always and everywhere a monetary phenomenon, it was crystal clear that 2.6% YoY inflation was likely to explode higher,” he continued.
It’s hard to argue with Wilson when the discussion is framed that way, and there’s little question that fiscal stimulus was part and parcel of the latent inflationary impulse in the US.
That said, I’d implore readers not to make the mistake of taking Friedman’s axiom as gospel in a world where geostrategic realignments, on-shoring, re-shoring, de-globalization and persistent supply chain frictions are virtually guaranteed to define the macro outlook for the next decade. If you take Friedman’s famous quote literally, assume it’s universally applicable, unassailable and admits of no caveats, the implication is that none of those factors will matter as long as the money supply is growing more slowly than the economy. That’s a perilous assumption in today’s macro environment.
Still, it’s obvious now that we were wrong to abandon monetarism altogether, dubious as it probably is in most circumstances. Had we at least incorporated it into our reaction function in 2020 and 2021, we might’ve made “better” decisions, depending on your definition of “better.”
As to whether the chart (above) is supposed to be taken as literally as some take Friedman, Wilson suggested it’s more of a conceptual guide, not necessarily a definitive roadmap.
“Given the leading properties of M2 for inflation, the seeds have been sown for a sharp fall next year,” he wrote. “The implied fall in CPI outlined would be highly out of consensus, and while it won’t necessarily play out exactly as in [the] chart, we believe it’s directionally correct.”
Plainly, that has far-reaching implications for the Fed, and also for traders and investors, who Wilson suggested “may be as offside on inflation today as they were in March 2021, just in the opposite direction.”
Fingers crossed. I’d love that.
You stated the facts nicely, as always. It seems Wilson has a pretty good eye for meaningful variables that touch and affect the economy. And I see value in his words. His recent assessments and judgements about what’s actually meaningful and impactful make sense in the landscape.
Wilson is obviously sharp. It’s very helpful to have a window of his perspective. My guess is that he would be the first to tell you to take his assessments with a grain of salt. But I’m not interested in making any big moves. I just want to have an idea of what we might see unfolding on the near horizon. Like a lot of investors, my eyes are glued to the investment horizon, despite Russia’s war with Ukraine and China’s recent, potentially self-destructive decisions about how they govern their people.
Yeah, Wilson is pretty intuitive beyond just what’d you’d need to be a top-down equities strategist. He’s good. He really is. Although I should note that I don’t know Mike. I know a lot of these guys (not “know” in the sense that we’d go on vacation together or something, but loosely know them). I’ve never spoken to Wilson, though, so it’s hard for me to say for sure how sharp he actually is. But I’ve read his notes for as long as I can remember and there’s never been a single time when I’ve thought “No, that’s totally off base.”
Just several hours ago, I was checking on M2 statistics at Fred. As of the beginning of October, M2 is still quite some ways below its usual seasonal April peak, something which may not have happened anytime in the recent past. My concern is of course what happens to stocks in such a scenario, as prior similar instances (of lesser magnitude) preceded routs in the market (1987, 2008, 2015, to name a few). Perhaps its the “correlation but not causation effect”, but I have some doubts.
We did get a nice correction already (~19% decline from Aug peak to October low), but perhaps (I hope) it will resume. My favorite short term indicator (CNN’s fear and greed) points to the possibility of at least some near term pullback
Is US M2 growth powerful enough to explain the global inflation change? We’re not the only ones with a lot higher inflation than expected.
Wilson is a really fine strategist
Inflation evaporation in 2023 would indeed be a pain trade.
Does a decline in M2 imply lower system liquidity that could make US Treasurys more volatile in a QT environment?
Where are the cpi and m2 data from? I’d like to have a further look.
This is helpful- I think it is important to link this to net open postions and commitment of traders data. I also think that politics and and war/peace issues matter more than they normally do right now…I do think that when the dust settles from central bank interest raises we could have more price discovery than we have had in a long while. As a former trader, I welcome that. It will be interesting to see what the top 20% will do if their wealth declines another 20% (I have no idea if this will happen)…