Morgan Stanley’s Mike Wilson told a familiar story on Monday.
I won’t spend too much time on Wilson’s latest given that it broke no new ground. That’s not a criticism. There’s no new ground to break.
He began by noting that over the past few months, US growth outcomes have surprised on the downside (relative to consensus) while inflation has generally surprised to the upside. The figure below illustrates the point.
Wilson called that “a challenging combination because it has meant the Fed can’t cut rates yet even though it may make sense to in order to keep the expansion going into next year.”
He went on to describe the US macro narrative as a good news/bad news dichotomy.
The good news, Wilson wrote, is that loose fiscal policy and spending on the part of corporate America’s mega-cap “haves” is currently “keeping the headline economy looking good on the surface.”
The bad news is, that superficial buoyancy — “resilience” — is “also keeping inflation elevated,” which in turn prevents the Fed from cutting rates.
Although America’s haves (both at the corporate and household level) are insulated from the impact of restrictive policy settings (they arguably benefit from high rates), the “have-nots” aren’t so lucky. Fed policy, Wilson reiterated, is “too tight for many economic participants.”
There’s a lively (read: contentious) debate about whether current policy settings actually count as “restrictive,” but I’ve been keen to emphasize that just as the neutral rate can vary depending on the time horizon (i.e., short run neutral versus long run neutral), it also varies by economic agent. Here’s how I put it in the June 1 Weekly:
Although… current policy settings are just barely into restrictive territory at the economy-wide level, [f]ive-handle Fed funds means 29-handle card rates and 11-handle used car loans for Americans with less-than-excellent credit. A Fed that hikes [further] is a Fed that condemns those borrowers entirely, and the same dynamic’s generally true for businesses: The have-nots which rely on loans, revolving credit and floating-rate debt would see their already thin margins squeezed even further.
I think Wilson would generally agree with that assessment.
On Monday, he suggested it’s a fool’s errand to discount the yield curve, which is currently experiencing the longest inversion without a recession in 100 years. “We think it’s hard to argue with the curve,” he said, adding that in Morgan Stanley’s view, it’s “still a valid indicator of interest rate policy.”
“When combined with high price levels for many goods and services, the end result is a crowding out of many parts of the economy and consumers,” he warned.
What’s better for have-nots: ~2% inflation or sub-4% unemployment?
Recognizing the Fed’s mandate does not, strictly speaking, include what’s better for have-nots.
They feel the inflation all the time. But, unless they or somebody close is unemployed, it’s not their problem.
That.
What this cycle shows is that, politically at least, unemployment is less costly than inflation… Good to know.
The inverted curve is the necessary condition. The sufficient condition is wider credit spreads. As Wilson points out, some are already wide. But some are not yet there. When the rest go, that is Mrs (O’)Leary’s cow kicking over the lantern. When does that happen? If you could tell me that I could tell you when we get the next downturn. That’s when credit gets turned off and things go quickly south from there.
I’m surprised that the writer would seem to conflate individual havenots and corporate have nots in this discussion. I hope the best for individuals and ill-effect of monetary policy on them should be mitigated. However corporate have-nots cannot go bankrupt fast enough to my taste to free workers and capital for better opportunities. Who wants to be 80s Japan? Shouldn’t corps disappear regularly at the end of their original product lifecycle?
Small and medium businesses (SMBs) are inherently “corporate have-nots” in this context, since they cannot tap the bond market.
… and since they are usually simple business, they often have plenty of competition, which means their margins are usually very thin indeed.
Along with what JL mentions, here’s something else he probably knows some things about.
You mention freeing up capital through bankruptcies. A problem with such “Austrian School” theories is that, in the real world, many bankruptcy proceedings don’t only take days or weeks. Would you take the over/under on 2.5 years for the Lehman bankruptcy settlement which freed up capital?
Also, when a SMB goes BK, not much capital is freed up. SMBs don’t usually have much capital, they live on cash flow and loans, when SMB BK rates rise banks cut back lending.