Larry Summers Sketches The Coming Recession

On the eve of a jobs report which argued for the persistence of an overtly hawkish bias from US monetary policymakers, I wrote that “terminal rate expectations are now generally in the range where the staunchest Fed critics insisted rates would probably need to peak.”

I was responding to comments from readers who (correctly, as it turns out) suggested Jerome Powell erred in not pushing back on the recent easing in financial conditions when he had the opportunity during a closely-watched speech this week.

“At least a few Fed officials are pretty clearly on board with 5.5% or even 6%, which would be higher than some Fed critics have suggested,” I said, in the same response.

When I mentioned “a few” officials, I was referring mostly to Jim Bullard and when I mentioned “some critics,” I was referring mostly to Larry Summers and Bill Dudley.

On Friday, following the jobs report, the market priced peak Fed funds in the neighborhood of 4.92%. That was up from 4.86% on Thursday, but well below the highs seen in and around the November FOMC meeting (figure below).

Officials are sure to upgrade their forecasts at the December meeting. The new projections will doubtlessly reflect a Committee determined to bring rates to at least 5%.

In that context (i.e., in the context of what the new SEP is likely to show), market pricing is probably not aggressive enough, particularly in light of the jobs report and the high odds of another upside inflation surprise at some point.

True to form, Summers said Friday that “five is not a good best-guess” for the terminal rate. “Six is certainly a scenario we can write,” he told Bloomberg’s David Westin.

Summers recapped November payrolls. Wage growth, he said, is “the best single measure of core underlying inflation.” If that’s accurate, then NFP argued for persistent, sticky price pressures, and thereby a stubbornly hawkish Fed.

Wage growth ran at twice the expected monthly rate in November (figure above), and upward revisions were unwelcome news for those of a dovish persuasion.

“My sense is that inflation is going to be a little more sustained than what people are looking for,” Summers went on to say. “I suspect [the Fed] is going to need more increases in interest rates than the market is now judging or than they’re now saying.”

He mentioned Paul Krugman, who conceded that the pace of wage growth poses an upside risk for inflation. “When the data don’t tell you what you want to hear, you have to listen. I was a lot more optimistic about near-term inflation at 8:29 this morning than I am now,” Krugman tweeted, referencing the MoM AHE prints.

“Look, every time they revised their forecast for inflation up, they revised their forecast for unemployment up as well,” Summers said, frankly. “Gosh, we’ve all been at the airport and they say it’s leaving at 7:30 and then they say it’s leaving at 8:30 and then they say it’s leaving at 9:30 — when I see that happening, I think it’s leaving at 11:00.”

The implication was clear enough: Summers thinks inflation isn’t going away anytime soon, he thinks the jobless rate is likely to be higher than the Fed is willing to project and he thinks rates aren’t going to stop at 5%. “I hope I’m wrong,” he added.

For what it’s worth, the market thinks he is — wrong, I mean (figure below).

On net, traders still sees rate cuts commencing in the back half of next year and, again, terminal rate pricing was below 5% as of Friday afternoon. That’s not consistent with Summers’s pseudo-projections.

The problem is that Summers has been right this cycle. During the same remarks to Bloomberg, he cast considerable doubt on the soft landing narrative, citing the still yawning disparity between job openings and workers willing to fill them, before sketching the coming recession for Westin:

Consumers run out of their savings and then you have a Wile E. Coyote-kind of moment, where consumption falls off. At a certain point, people start putting their houses on the market and then you see house prices falling and then other people rush to put [theirs] on the market. You see credit drying up and when credit dries up, people can’t pay back their old borrowing. Once you get into a negative situation, there’s an avalanche aspect.

He referred to the Sahm Rule. I’d be remiss not to note that Claudia Sahm (for whom the rule is named) is now famous for expressing what I’ll politely call extreme consternation at some aspects of the economics profession, including and especially the extent to which it’s beholden to domineering male antagonists.

She’s quibbled with Summers over his invocation of her rule previously (see below):

Currently, the Sahm rule is 0.03, which is 0.47 percentage point below the trigger. We are not in a recession now. https://t.co/A06pSKLxG1 pic.twitter.com/f30feoP4ML

— Claudia Sahm (@Claudia_Sahm) September 8, 2022

That’s from September. Sahm might’ve responded to Summers’s latest respectful, on-air citation, but she swore off Twitter a few hours previous, citing Elon Musk.

The day before, she wrote the following:

Conversation this morning with a Fed watcher.

Him: You were wrong about inflation last year, and Larry was right? Why should we listen to you now?

Me: First, Larry was right for the wrong reason. None of the hawks talked about delta, Omicron, and Putin.

Me: In addition, Larry and the hawks, this time last year, said we would be in a recession in 12 months. We are not. They were wrong.

Moreover, inflation has clearly turned down, and more relief is coming. They said we must have a recession for it to move down. Big wrong.

It’s not about me. It’s not about them. There is blame and wrong to go around. I get some, and they do too.

Now, let’s all gather ’round in December 2022, look hard at the data and put our thinking caps on.

The burden of proof is on the hawks now. I am waiting.