Year: 2023

The Fed Now Has a Good Chance at a Soft Economic Landing Inflation is falling fast. If the monetary hawks aren’t careful, they could fly into a recession.

( By Alan S. Blinder, professor of economics and public affairs at Princeton, vice chairman of the Federal Reserve, 1994-96)

(…) Remember, the Fed’s job is to reduce inflation, not to drive the economy into the ground. Some observers insist that conquering inflation requires a recession. But that’s based on Phillips curve reasoning: High unemployment is supposedly needed to slow the growth of wages, which in turn will slow the growth of prices. Maybe. But what if that proves wrong here—as it has for most of the 21st century?

Consider these amazing facts. When the Fed started tightening in March 2022, the unemployment rate was 3.6%. Since then, about four million net new jobs have been created, and the unemployment rate today stands at 3.4%. Yet inflation has come way down, not up; wage increases are moderating, not accelerating; and less inflation from rents is in our future. We also know that the effect of tight money on inflation is long delayed. Maybe, just maybe, the Fed can finish off the dragon without killing the economy.

Six months ago, before all the good inflation news started pouring in, I thought the odds were strongly against achieving a soft landing. Now they look to be at least 50-50, maybe better. And if a soft landing is possible, shouldn’t the Fed try for it?

That’s why I hope there’s a lot more arguing inside the FOMC than the central bank is letting on.

The chart below shows CPI-Services inflation with the YoY change in wages for production and nonsupervisory employees (81% of all employees), both within a very stable 2-4% range over 25 years (pre-pandemic).

During that period, the unemployment rate ranged between 3.5% and 6.0% except for 6 years post GFC, U.S. real GDP averaged 2.5% while oil prices fluctuated wildly from $11/bbl in 1998, to $134 in 2008, to $30 in 2016, to $71 in 2018 and to $115 in 2022.

This other chart plots wage inflation with the unemployment rate (inverted) between 1986 and 2019. Wage inflation has always peaked around 4% even when unemployment was very low. That was also the case just before the pandemic.

If we incorporate core inflation, we see that real wage growth tends to peak at 2% even at peak employment. The Phillips curve works, but only up to a point.

This other chart plots CPI-Services ex-Shelter, the current focus at the FOMC, with oil prices. CPI-Services ex-Shelter was always rapidly responsive to spikes in oil prices before the GFC shock and right after the pandemic. After wages, energy is the second most important cost for most service providers.

All this to suggest that, maybe, the FOMC is fighting elusive windmills. MoM, wages have decelerated from +5.7% a.r. in the first half of the year to +4.6% in Q3, to +4.3% in the last 3 months, +3.6% in the last 2 months and +2.9% in January.

The effect is already seen on services inflation (MoM), particularly when stripping out shelter. The recent drop in oil prices should soon kick in as well.

January CPI is out next Tuesday.

• Fed’s Christopher Waller Says He Is Prepared for Longer Inflation Fight Federal Reserve governor Christopher Waller said inflation doesn’t look poised to rapidly fall to the central bank’s 2% target, leaving policy makers with more work to do as they try to bring rising prices under control.
• “We need to attain a sufficiently restrictive stance of policy,” New York Fed President John Williams told a Wall Street Journal live event in New York. “We’re going to need to maintain that for a few years to make sure we get inflation to 2%.”
• Governor Lisa Cook said officials were committed to curbing inflation and further tightening was warranted, though she favored maintaining a gradual approach. “We are not done yet with raising interest rates, and we will need to keep interest rates sufficiently restrictive,” she told an event in Washington. Moving in smaller steps “will give us time to evaluate the effects of our fast actions on the economy.”
• Minneapolis Fed President Neel Kashkari: “There’s not yet much evidence, in my judgment, that the rate hikes that we’ve done so far are having much effect on the labor market,” he said. “We need to bring the labor market into balance so that tells me we need to do more.”
• Jamie Dimon reiterated that the Fed may need to hike above 5%, Reuters reported.

Recession Watch: US doing all it can to avoid recession

Data released at the end of last week have caused us to reassess at least the near-term prospects for the US economy. In our Global Outlook, Winter 2022, finalised in early December, we described a central scenario that saw the US economy enter a relatively mild recession, beginning in Q1 of this year. That now seems unlikely.

Last Friday we learned first that the US economy added 517,000 jobs in January, far in excess of the Reuters Poll consensus of 185,000. But it was not just one month of surprisingly strong employment numbers. Just as economists were systematically surprised by the persistence of inflation through late 2021 and into early 2022, they have more recently been systematically surprised by the resilience of the US labour market, with the change in non-farm payrolls averaging some 100,000 more than expected in each of the past twelve months.

Later that same day, the ISM survey of non-manufacturers composite index rebounded sharply in January from a surprisingly weak December reading. The US economy has got off to a flying start in 2023.

It was about a year ago that we first became concerned by the prospects for a US recession. By early summer, we gave it close to an evens chance, and described two conditions that we felt would be necessary, in the face of falling real incomes and rising interest rates, for the US economic recovery to continue uninterrupted.

First, in a scenario we labelled ‘Time to dissave’, US households would need to eat at least a portion of their pandemic savings. Second, inflation expectations would need to fall quickly back to target. Were this not to occur, we said, it was likely that material upward pressure on wages would lead to large second-round effects from the initial price spikes, requiring a much larger monetary policy response.

Both these conditions have been met.

It was in January 2022, just as CPI inflation moved ahead of wage growth, that the US household savings ratio suddenly dropped sharply below its pre-pandemic average of 7.6%. From that point on, our estimate of US pandemic savings began to fall. One year on, they had fallen by around one third, suggesting that US households could continue to decumulate their pandemic savings at the current pace for a further two years.

If we look at more timely measures of US wage and price inflation than the usual headline measures that are reported on a twelve-month basis, such as the three-month annualised percentage change in each, it is clear not only that both wage and price inflation have been falling, but that real wages are now rising. More encouraging still, if we look at the Atlanta Fed’s decomposition of CPI inflation into what they call ‘sticky-price’ and ‘flexible price’ components, it is not just flexible-price inflation that is falling: sticky-price inflation is falling too.

When firms choose to change their prices only infrequently, perhaps because of the substantial costs involved in doing so, then they are likely to give more careful consideration to the outlook for inflation. In that respect, the sticky-price component may be more forward-looking than the flexible-price component. Sticky prices are likely to capture the second-round effects of the larger, flexible price changes.

So the US economy is evolving in just the way we said it would need to do if a recession were to be avoided. Those two conditions were necessary. They may not, however, be sufficient.

We can be reasonably confident that the US will not enter recession in the current quarter. And the odds of a US recession occurring within our three-year forecast horizon have almost certainly fallen since we published our Global Outlook, Winter 2022. What we continue to find troubling is the scale of the historical precedent.

We have reminded our clients on a number of occasions that the US has never avoided recession with consumer confidence as low as it has been in recent months. It has once avoided recession with inflation as high as it has been in recent months, but that was as long ago as 1952. This time we add to our list of comparators an analysis of previous US hiking cycles, shown in the chart below, where each coloured line represents an individual cycle.

We are currently working our way through the ninth US hiking cycle since 1970. Of the eight completed cycles, three did not lead to a recession within four years — those were the ones that began in March 1983, February 1994 and December 2015 (we are not counting the COVID pandemic, which in any case was just over four years after the December 2015 hiking cycle began).

For the five hiking cycles that did lead to a recession within four years, we have stopped the line short at the point where the economy entered recession. There are at least two points of interest:

• The current hiking cycle is the second fastest on record. The fastest on record was the one that began in September 1980, which also lead to the fastest recession, with activity peaking just ten months later, in July 1981.
• The three hiking cycles that did not lead to a recession within four years all saw a smaller cumulative tightening than we have seen to date in the current cycle. Every time that the US federal funds rate has risen by as much as it has over the past year, the US had entered recession within a few years. (…)

Where does this leave us? It is widely recognised that recessions are hard to predict, and this is something I have written about several times in the past. They are non-linear events, often triggered by a sudden change in behaviour, perhaps following a sudden reappraisal of the economic outlook by many firms or many households. Nevertheless, we feel we must continue to try.

To date, the US economy has evolved just as we said it must if recession were to be avoided — US households have begun eating into their pandemic savings, and they could continue to do so at the current pace for a further two years. CPI inflation and wage inflation have both fallen, including ‘sticky-price’ inflation which is likely to capture second-round effects, and yet CPI inflation has fallen further, boosting real incomes. That makes recession unlikely in the near term, and definitively less likely than we imagined at the time of our Global Outlook, Winter 2022.

One indicator that continues to flash red is the level of long-term real rates of interest. These have risen materially, by 200 basis points or more, in many major economies, including the US. A decades-long decline in long-term real rates of interest, which many had attributed to demographics, had supported valuations that otherwise appeared stretched in many asset markets, including residential property markets.

House prices have begun to fall sharply in some countries. In Sweden they have fallen some 12% since the summer. They have fallen for five months in a row in both the US and the UK. In our Global Outlook, Spring 2023, which we shall be presenting to clients next month, we are likely both to push out the point at which the US enters recession if it does at all, and to reduce the weight we attach to scenarios that include a US recession.

FYI: Morgan Stanley’s US cycle indicator has flipped from ‘expansion’ to ‘downturn’. Historically, this phase has supported a defensive posture and meant a worse backdrop for risk asset returns, changes in sector leadership, and a good environment for fixed income. (The Market Ear)

Morgan Stanley

Fed’s Jerome Powell Braces for Longer Inflation Fight Amid Hiring Surge Process of lowering inflation to goal of 2% is likely to take ‘quite a bit of time’

A government report Friday that showed hiring accelerated in January was “certainly strong—stronger than anyone I know expected,” Mr. Powell said Tuesday during a moderated discussion before the Economic Club of Washington, D.C. “It kind of shows you why we think this will be a process that takes a significant period of time.” (…)

The process of lowering inflation to the Fed’s goal of 2% “is likely to take quite a bit of time. It’s not going to be, we don’t think, smooth,” Mr. Powell said. “It’s probably going to be bumpy.”

The expectation that inflation “will go away quickly and painlessly…is not the base case,” he added. “The base case for me is that…we’ll have to do more rate increases, and then we’ll have to look around and see whether we’ve done enough.” (…)

“We’re going to react to the data,” he said. “So if we continue to get, for example, strong labor market reports or higher inflation reports, it may well be the case that we have to do more and raise rates more than has been priced in.” (…)

Mr. Powell has for the past three months justified continued interest-rate increases by noting still-tight labor markets, elevated wage pressures and high inflation for labor-intensive services. “We’re not seeing disinflation there yet, and that’s going to take some time,” he said Tuesday. “We’re going to need to be patient.”

Later, he returned to that component of service-sector inflation failing to slow down this year as one of the most concerning developments facing the Fed. “That’s what I worry about,” he said. (…)

Mr. Powell also modified his qualification of the labor market, from “very, very strong”, used in the past several months to “extraordinarily strong.”

He also said:

• “the Fed hasn’t yet achieved a sufficiently restrictive interest-rate setting.”
• If the data continue coming in stronger than the Fed expects, then the Fed “would certainly raise rates more.”
• “Shortage of workers feels more structural than cyclical.”
• “That isn’t going to change,” Powell says of the 2% target.
• “My guess is it will take certainly into not just this year but next year” to get to 2%.
• Powell says the Fed isn’t actively considering sales of mortgage securities.

Yesterday, from the NY Fed:

• Inflation Persistence—An Update with December Data

(…) As many sectors continue to experience high price volatility, uncertainty is high resulting in a 68 percent probability band (shaded area) of (3.2, 4.2). However, as the first chart shows, the probability band remains below the standard twelve-month core PCE measure, which in December declined to 4.4 percent.

PCE and Multivariate Core Trend

Sources: Bureau of Economic Analysis; authors’ calculations.
Notes: PCE is personal consumption expenditure. The shaded area is a 68 percent probability band.

Despite the apparent stability of the trend in the last two months, there were notable changes in its composition. The core goods trend subtracted 0.2 percentage points (ppts) from the MCT, while housing added 0.2 ppt. The core services ex-housing trend was essentially flat.

Considering this, the contribution of housing inflation to the increase in the persistent component of inflation from the onset of the pandemic, at about 1.1 ppts, is now more than twice as much as the cumulative contribution of goods and services ex-housing (0.4 ppt each), as shown in the following chart.

Inflation Trend Decomposition: Sector Aggregates

Sources: Bureau of Economic Analysis; authors’ calculations.
Note: The base for the calculations of the contributions to the change in the Multivariate Core Trend is the average over the period January 2017-December 2019.

What this NY Fed’s piece shows is that the trend in core inflation has stabilized below 4.0% with both goods and services-ex-housing contributing equally to the slowdown. Housing remains the inflation villain that everybody expects to become friendly sometime this year.

But the Cleveland Fed, in a Jan. 13 working paper, does not see housing inflation that much friendlier, not even through 2025.

Housing services inflation is projected to decline at a steady rate through late 2024, but then its downward progress stalls out, likely reflecting the sluggish dynamics of rent. During 2025, it settles in at a 4.5 percent pace, before continuing to decline briskly, reaching 3.8 percent by early 2027.

Actually, that paper’s authors would not bet heavily on the FOMC’s recent inflation forecast:

We first present the model projection for core PCE inflation through 2025, along with 70 percent confidence intervals, and the [FOMC’s] SEP [Summary Economic Projections] in Figure 3. Our model projections are conditional on the December SEP path for unemployment.

The SEP projection initially lies above the model’s mean projection, and outside the 70 percent confidence interval. This is because, in our model, the projected 2023 uptick in the unemployment rate in the SEP projection puts downward pressure on all of the inflation variables.

Thereafter, however, the persistence of inflation reflected in our model estimates becomes evident, and progress toward the 2 percent target slows.

Conversely, the SEP projection then continues its steady downward drift. This steady decline moves the SEP projection within the confidence interval, where it remains for most of 2024.

However, thereafter, the SEP projection continues to move steadily lower, so that it moves outside of, and well below, the confidence interval. Hence, from late 2024 onward, the SEP projection is assessed as too optimistic relative to our model’s assessment. Our model forecast is a touch below 2.7 percent by the end of 2025; it does not reach 2.1 percent inflation until several years later. (…)

Our model sees core goods inflation rebounding from -0.5 percent inflation in 2022Q3 to near 0 in early 2024, then slowing to a -0.40 percent pace in 2025.

Non-housing core services inflation is projected to fall to 3.8 percent by the end of 2023, driven by downward pressure from the rising unemployment. Then its downward progress slows so that it decelerates to 3.4 percent by the end of 2025.

Housing services inflation is projected to decline at a steady rate through late 2024, but then its downward progress stalls out, likely reflecting the sluggish dynamics of rent. During 2025, it settles in at a 4.5 percent pace, before continuing to decline briskly, reaching 3.8 percent by early 2027. (…)

We next provide a number of additional inflation projections, conditional on three alternative unemployment rate scenarios: a soft landing scenario, a moderate recession scenario, and a severe recession scenario.

The soft landing scenario, which conditions on the projected unemployment path from the June SEP, has unemployment peaking at 4.1 percent by the end of 2024.13.

The moderate recession scenario conditions on a path for unemployment from 2023Q1 onward that mimics the 2001 recession. For this path, unemployment tops out at 5.6 percent in 2025Q3.

Finally, the severe recession scenario (inspired by the Summers/Ball/Leigh/Mishra assertions) conditions on a path for unemployment from 2023Q1 onward that mimics the 1973 recession. For this path, unemployment tops out at 7.8 percent in 2024Q2, although unemployment averages 7.4 percent over the year.

Unemployment rates in all scenarios, with the exception of the severe recession, are assumed, after 2025Q4, to descend linearly to hit 4 percent by the end of 2029 (or in the case of the soft landing, by the end of 2025).

(…) Notice, however, that once the deceleration pressures ease, progress toward 2 percent slows markedly. Inflation is more persistent than is commonly believed. (…)

Looking ahead, our model projects that inflation only very gradually falls back to 2 percent. Progress toward target is very much influenced by the path that unemployment will take over the next several years.

Conditional on the December SEP median unemployment rate projections, inflation is projected to still be nearly 2.7 percent by the end of 2025, far above the SEP’s median projection of 2.1 percent.

A moderate recession (roughly equal to the recession of 2001) would put inflation at 2.4 percent by the end of 2025; conversely, a soft landing (which we define as the path of unemployment in the June SEP projection) would put inflation a touch above 2.8 percent by the end of 2025.

What kind of recession would it take to hit the SEP projection for inflation, according to the model developed in this paper? We investigate the claim of former Treasury Secretary Lawrence Summers (reported in Aldrick, 2022) and the supporting assessment of Ball, Leigh, and Mishra (2022) that it will take two years of 7.5 percent unemployment from its current low level to bring inflation down to its 2 percent target. We find that one year of 7.4 percent unemployment would accomplish this task.

• Wholesale Used-Vehicle Prices Increase in January

Wholesale used-vehicle prices (on a mix, mileage, and seasonally adjusted basis) increased 2.5% in January compared to December. The Manheim Used Vehicle Value Index (MUVVI) rose to 224.8, down 12.8% from a year ago. January’s increase was driven in part by the seasonal adjustment. The non-adjusted price change in January was an increase of 1.5% compared to December, moving the unadjusted average price down 11.0% year over year.

(…) we initially estimate that used retail sales increased 16% in January from December and that used retail sales were up 5% year over year.

Using estimates of used retail days’ supply based on vAuto data, January ended at 44 days’ supply, down from 56 days at the end of December and six days lower than how January 2022 ended at 50 days. (…)

January’s total new-light-vehicle sales were up 4.2% year over year, with the same number of selling days as January 2022. By volume, January new-vehicle sales were down 18.6% from December. The January sales pace, or seasonally adjusted annual rate (SAAR), came in at 15.7 million, a 4.1% increase from last year’s 15.1 million and up 17.7% from December’s revised 13.4 million pace. (…)

(Bloomberg)

U.S. consumer credit grows at slowest pace in two years in sign of economic worries

The amount of credit consumers used in December rose by a scant 2.9% — the smallest uptick in more than two years — as Americans tightened their belts in response to a slowing economy.

Consumer credit rose by $11.6 billion in the final month of 2022, Federal Reserve data showed. Economists had expected a $26 billion increase, according to the Wall Street Journal forecast.

Revolving credit, like credit cards, increased at a 7.3% annual rate in December. That’s the smallest increase in a year and a half.

Auto and student loans, known as non-revolving credit, rose at a 1.5% pace. That category of credit is much less volatile, but it’s the smallest increase since the early stages of the pandemic in 2020.

• Half in U.S. Say They Are Worse Off, Highest Since 2009

Macklem Says Homeowner Debt Helped Spur Early Bank of Canada Rate Pause

Bank of Canada Governor Tiff Macklem conceded that rate hikes have hit the country’s homeowners hard, saying the impact of higher borrowing costs on consumers is a major reason why he chose to hit pause before the US Federal Reserve.

In an interview with Bloomberg News, Macklem said the central bank needs time to gauge how households and businesses are adapting to higher rates before it makes any further moves.

Canadians “are more indebted today than they’ve ever been,” Macklem said after a speech Tuesday in Quebec City. Although some households were able to build up cash reserves during the pandemic, “extra savings are probably not going to last as long as the higher debt.” (…)

The real estate market will probably soften further before it stabilizes later this year, he said. (…)

Chinese Consumers Hoard Cash After Confidence Takes a Hit Beijing is trying to kick-start growth, but one challenge it faces is Chinese citizens borrowed less and saved more last year and it isn’t clear how long it will take to return to freer-spending ways.

(…) “Confidence has plummeted in the past year,” said Zhiwu Chen, chair professor of finance at the University of Hong Kong, referring to both individuals and businesses in China. “When people are uncertain about the future, their first reaction is to save money.”

When China’s government brought an end to its strict zero-Covid policy and unveiled a series of measures designed to help revitalize the property sector between November and December, stock prices jumped in anticipation of a recovery. But Ting Lu, an economist at Nomura, thinks it will take until the third quarter for consumption to recover to “near prepandemic levels.”

The generation of Chinese citizens who emerged from the pandemic may have similarities to those in the U.S. who came out of the Great Depression, said Li-Gang Liu, head of Asia-Pacific economic analysis at Citi Global Wealth Investments. There could be a long-term shift in their desire to save, he said. (…)

Although the U.S. economy experienced a boom after—and even during—the pandemic, Chinese consumers have emerged from the worst of the crisis with little confidence. This is partly because the Chinese government didn’t pay subsidies to its citizens, as the U.S. and governments elsewhere did, meaning many people who lost jobs and income didn’t have a safety net to fall back on, Mr. Chen said. That experience may have taught people that they need to save more to ensure their security, he said.  (…)

The same survey, which covered 20,000 depositors in 50 cities across the country, asked whether people would prefer to save, spend or invest. Around 62% of the respondents chose saving, 23% picked spending and only about a sixth intended to invest more. In a similar survey in 2019, around 45.7% planned to save more. (…)

China Car Sales Drop Amid Weaker Buying Over Lunar New Year

Overall, passenger car sales in China slumped 38% year-on-year in January to 1.29 million, the PCA data showed. That was down 40% from December and the lowest since at least April last year, when China was in the throes of Covid lockdowns. (…)

A total of 332,000 new-energy vehicles, including pure electric cars and plug-in hybrids, were sold last month, down 48.3% from the month prior and 6.3% lower than sales in January 2022, according to final data released by the China Passenger Car Association Wednesday.

Chinese automaker BYD Co. and US manufacturer Tesla Inc. led the pack, shipping 151,341 and 66,051 cars, respectively. Some 26,843 China-made Tesla Model 3 sedans and Model Y SUVs were delivered to local customers, while 39,208 were exported. Momentum picked up for Tesla in January after another round of aggressive price cuts. The EV pioneer was forced to cut output in December from its Shanghai factory amid muted demand. (…)

The scrapping of a national subsidy on EV purchases at the end of 2022 also encouraged customers to place orders in the fourth quarter. Sales of Xpeng Inc., Nio Inc., and Zhejiang Leapmotor Technologies Ltd. all witnessed drops in January. (…)

How golden is the golden cross?

Usually a good signal, but we have seen poor results as well. Tier1Alpha notes: “This indicator also has a strong history of positive returns after a cross has been made, especially when looking around three months out from the crossover. With that said, there are quite a few examples of negative returns as well, especially pre-2000, and the strength of those returns varies greatly, with the max being 18.94% in 2009 and the weakest return being -13.4% in 1990.”

Tier1Alpha

Refinitiv

• We haven’t seen such a low reading when it comes to people wanting to increase equity exposure. More upside pain in equities? (The Market Ear)
  

JPM

Crypto Absent from Super Bowl Ads

One year after the Crypto Bowl, it’s out with the new and in with the booze for Super Bowl commercials.

Fox, which has broadcasting rights this year, has sold all of its advertising airtime for Super Bowl LVII, sticking with the old reliables of beer and snacks, with crypto nowhere to be found.

Back to basics, so to speak…