Fed plans to raise rates as soon as March to cool inflation

[jaichind]

Hopefully, now the Fed faces reality and put a 75 bp and in my view a 100 bp increase on the table for the next Fed meeting.  The market pricing clearly thinks this is the case (at least the 75 bp part)

[jaichind]

April YoY PPI at 11%  Market expected 10.7%.   Par for the course given recent trends

[jaichind]

Hopefully, now the Fed faces reality and put a 75 bp and in my view a 100 bp increase on the table for the next Fed meeting.  The market pricing clearly thinks this is the case (at least the 75 bp part)

So we should expect mid-term stagflation?

I would say that the equities markets are pricing in around a 50% chance of a recession next year.  I think if it falls another 5% or so then the chances of a recession next year is very high. 

[jaichind]

About what I assumed, although we might get the official "recession" as soon as next quarter.

Anyway, I have already started buying the dip a bit, but not sure how much I should leave for later. Think we could lose more than 10% to ATL from this point?

The way the inventory cycle works makes the chances of official recession unlikely next quarter.  Still, economic growth clearly is slowing down.  There is still some reason to believe that when the likely recession comes it will most likely be more shallow than 2008 and more on the order of 2001.  Right now inventory levels are not that high and the usual reason why recessions are deep is large inventories that companies then burn through while they lower production.  This time around this factor will work in favor of shallow inflation.  The Fed still has dreams of holding down unemployment while rates rise to push down inflation.  This just seems unlikely and the Fed should accept reality and not risk a even worse recession and unemployment later down the line.

[jaichind]

Now Powell Reiterates 50 bp Hikes Are Likely in June and July. Sigh.  the Fed communications on this are all over the place and this signals significant divisions within the Fed.

[jaichind]

University of Michigan Consumer Sentiment Index continued to stay at a very depressed level.  It is at the worst level since the early 1980s with the exception of being slightly above late 2008-early 2009 levels (Great Recession) as well as the Summer of 2011 (Budget crisis).

[jaichind]

University of Michigan Current Economic Conditions Index  came in at 63.6.  The only 2 months that were worse than this since 1980 is Oct 2008 and Nov 2008.  Every other month over the last 42 years is better than this reading for May 2022.

[jaichind]

University of Michigan Current Economic Conditions Index  came in at 63.6.  The only 2 months that were worse than this since 1980 is Oct 2008 and Nov 2008.  Every other month over the last 42 years is better than this reading for May 2022.

A stock market bear market, 8% inflation, record high housing prices, and a slowing economy is an amazing combination of things that aren't supposed to all happen at once.

Many people do not remember this but inflation was a major concern in late 2007 and most of 2008.  The Fed fund rate had to hit 5.25% in late 2007 and in July 2008 CPI YoY hit 5.6%.  I remember food prices were surging in early 2008 and inflation became a bigger concern which all were erased by the economic and financial crash of late 2008.  Just to be clear, the markets started to fall in late 2007 and had fallen over 20% from their peak by July 2008 before the big crash in Sept 2008.  At the same time unemployment in late 2007 was around 4.6% which was fairly low.

So today really looks a lot like mid-2008 in many ways with the exception that the Fed funds rates today are way behind the curve relative to 2007 2008.

[jaichind]

https://www.nytimes.com/2022/05/16/business/ben-bernanke-predicts-stagflation.html

"Ben Bernanke Sees 'Stagflation' Ahead"

Former Fed Chairman Bernanke said Fed leaders were too slow to react to surging U.S. inflation and as a result face a period of stagflation or a combination of stagnant growth and high inflation.

[jaichind]

https://news.yahoo.com/goldman-sachs-economist-slowdown-consumer-spending-151957462.html

"Goldman Sachs economist sees 'a slowdown in consumer spending'"

The same GS economist Jan Hatzius also said in an interview with Bloomberg said "Borrowing is going to be a short-term driver of spending, and I think has been to some degree" and "Consumer spending is going to be relatively slow. Income is going to be quite weak in 2022."

It seems if consumers are using leverage to deal with inflation then the economic slowdown is going to be worse than expected.  The Fed is riding the tiger and now it is getting harder and harder to get off.

[jaichind]

Walmart and now Target's profits both fell well short of expectations and had deep stock price declines.  So there goes the "inflation is high because of greedy capitalists/corporations" line.  Of course, that line never made since I am pretty sure capitalists/corporations were greedy before 2021.

[jaichind]

Fed Reverse Repo Facility Demand Jumps to a record $1.973 trillion.  This pretty much shows there is excess liquidity in the system as market players run out of places to stash short-term cash.    Another data point points to the need to drain liquidity from the market via aggressive raises in the Fed fund rate as well as unwinding the massive Fed balance sheet.  When that does happen the long term cost of the Federal debt will become clear there will have to be a fiscal adjustment as well after the economic downturn is over.

[jaichind]

Revised 2022 Q1 QoQ GDP came in at -1.5% from the initial -1.3%.  What is striking is that net exports knocked 3.2% off this figure which implies very robust demand but supply that cannot keep up with demand.  

Ever since 2008, the Fed has been operating under the assumption that real GDP is operating below potential GDP ergo ultra-loose monetary policy is needed to get demand to meet up with potential GDP.  The low levels of inflation, which is also about deleveraging from the 2007-2008 bubble, seem to validate the Fed assumption.

The latest GDP numbers seem to indicate a massive policy miss collectively by the Fed, Trump administration, Biden administration, and congressional leaders of both parties.  The COVID-19 lockdowns seem to have permanently lowered USA's potential GDP trajectory while all policy makers  
assumed that the post-2008 world where demand was always below potential GDP.  The result is the current inflationary crisis which now can only be solved by normalization of interest rates to a pre-2008 norm.

[jaichind]

Revised 2022 Q1 QoQ GDP came in at -1.5% from the initial -1.3%.  What is striking is that net exports knocked 3.2% off this figure which implies very robust demand but supply that cannot keep up with demand.  

Ever since 2008, the Fed has been operating under the assumption that real GDP is operating below potential GDP ergo ultra-loose monetary policy is needed to get demand to meet up with potential GDP.  The low levels of inflation, which is also about deleveraging from the 2007-2008 bubble, seem to validate the Fed assumption.

The latest GDP numbers seem to indicate a massive policy miss collectively by the Fed, Trump administration, Biden administration, and congressional leaders of both parties.  The COVID-19 lockdowns seem to have permanently lowered USA's potential GDP trajectory while all policy makers  
assumed that the post-2008 world where demand was always below potential GDP.  The result is the current inflationary crisis which now can only be solved by normalization of interest rates to a pre-2008 norm.

We were kind of on our way before the pandemic. Didn't we get up to 3%? We were at 5% before right?

This is where Brookings thought the USA was relative to potential GDP in early 2021



Clearly, they and the rest of the policy-making establishment were wrong.  Potential GDP clearly shrank during the 2020-2021 period.

But looking at the chart it is clear that the Trump tax cut of 2017 plus loose monetary policy most likely closed the GDP to potential GDP gap by the end of 2019.

[jaichind]

People with bad credit scores aren't getting mortgages anymore, but, if there's a systemic risk issue with financing for housing, it won't matter that these people seemed like good bets to lenders at the time. They are very exposed.

Learned nothing, forgotten everything.

Many of the financial innovations over the years that led to a crisis were and are good ideas but not well understood in terms of pricing and risk profile when they first came out.  In the end, they actually do become mainstream even though they were the cause of all sorts of problems when they first came out.  Junk bonds of the 1980s caused many problems but became mainstream by the late 1990s.  The MBS CDOs that were part of the 2008 crisis are now actually making a comeback and are becoming mainstream.

I never felt lending to those with poor credit ratings was a problem as long as the risk was factored into the interest rate.  This is why I always opposed anti-usury laws since the alternative was for those with poor credit ratings to go underground to get their funding.  Same in this case.  The pricing for these loans have to take risk into account and I think things will work out fine.

[jaichind]

https://www.cnbc.com/2022/06/01/jamie-dimon-says-brace-yourself-for-an-economic-hurricane-caused-by-the-fed-and-ukraine-war.html

"Jamie Dimon says ‘brace yourself’ for an economic hurricane caused by the Fed and Ukraine war"

Dimon said:
" Several aspects of quantitative easing programs “backfired,” including negative rates, which he called a “huge mistake.”"

[jaichind]

I think this signal is not as valuable currently due to the stark difference between 2-year and 10-year inflation expectations.  What is needed is a comparison of real 2-year and real 10-year yields.

[jaichind]

https://finance.yahoo.com/news/exclusive-musk-says-tesla-needs-070712003.html

"Exclusive-Musk feels 'super bad' about economy, needs to cut 10% of Tesla jobs"

Mush wants to cut jobs by 10% because he "feels super bad" about the economy.

[jaichind]

Bloomberg reports: Nobel laureate economist Robert Shiller sees a “good chance” of a US recession that’s at least in part the result of a “self-fulfilling prophecy” as investors, companies, and consumers grow increasingly worried about a downturn.

[jaichind]

May 2022 CPI YOY came in at 8.6% which is a good deal higher than the expected 8.2%.   Hopefully the Fed gets the message and act aggressively now before it is too late. 

[jaichind]

The unexpectedly high price increase came from food and energy which means the impact on the average consumer would be worse than these numbers would imply.   

[jaichind]

The CPI MoM increases hit 1.0% which means the run rate for USA CPI is almost the same as Russia. 

[jaichind]

Fed fund swaps clearly pricing in 50 bp each for the next 3 Fed meetings.   For the Dec meeting the swaps indicate a 25 bp increase. I suspect when we get to Dec it will also be 50 bp.   This means by the end of 2022 Fed Funds rate will be 2% higher than today which would be 3%  A start but no aggressive enough in my view.  Fed Fund rate should be at least 4% if not 5% by the end of the year.   The Fed is taking a lot of risk by being so timid. 

[jaichind]

The CPI MoM increases hit 1.0% which means the run rate for USA CPI is almost the same as Russia. 

I take that back.  Russia May CPI MoM just came in at .12% which is way lower than USA.  So going forward the USA run rate inflation will be higher than Russia.  Impressive given the sanctions Russia is under. 

[jaichind]

The University of Michigan Consumer Sentiment Index falls to 50.2 which is the worst reading ever in the history of the index when it started in 1978.  This level is below the worst levels achieved in the depth of the 2008-2009 Great Recession when they fell in the mid-50s.  It is also worse than the period in 1980 when the USA had a great inflationary surge.