Pro Perspectives 3/1/23

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March 1, 2023
 
There was a lot of attention given to today's U.S. manufacturing data, specifically the inflation component.
 
We know price pressures bounced back in January.  This was the first clue on February inflation. 
 
Prices were higher.  New orders were higher.  But the manufacturing index itself remains in contraction territory.
 
This had people chattering today about stagflation (hot inflation, slow or no growth) and recession. 
 
But let's take a look at the price data from today's report with some context …
As you can see, price pressures in this manufacturing report are bouncing, but from low levels compared to this time last year.
 
On the note of recession risk: Remember, we had a recession.  It was last year.  And the two consecutive quarters of negative GDP growth in the first half of last year, were indeed driven by the very catalyst that many are ascribing an impending recession to:  a Fed tightening cycle.  The recession is not looming, it already happened.
 
At this point, they've already normalized interest rates, inflation has cooled, inflation expectations are tame, and the economy is on pace to put up another (consecutive) growth quarter in the 2.5% area.
 
And now we have the growth catalyst of China coming in, after they finally scrapped zero covid policies.  The composite PMI out of China for the month of February, which measures economic activity in the manufacturing and services sector, was strong, well into expansionary territory, and above pre-covid levels. 
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Pro Perspectives 2/28/23

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February 28, 2023
 
Let's take a look back at July 27th, and discuss how it relates to today's Supreme Court hearing on Biden's student debt forgiveness plan. 
 
As you may recall, the Fed met on July 27th, and raised rates by 75 basis points. This was the second consecutive 75 basis point hike, and it left the Fed Funds rate in the range of 2.25%-2.50%. 
 
If we look back at the prior tightening cycle (2015-2018), that's right around the level where the Fed was forced to stop and reverse on their tightening campaign, as things started breaking in the financial system.  And, indeed, on July 27th, it was already known that the level of global rates (led by the Fed) were putting stress on the financial system (the European Central Bank had to intervene to fix the European sovereign debt market a month earlier).
 
With that, and with the stock market having already been slashed by 20%, and with the bubbles in the economy having been pricked, Jerome Powell (Fed Chair) called the Fed Funds rate of 2.25%-2.50% NEUTRAL (i.e. not accommodative nor restrictive of economic activity).  
 
And he said they would no longer "guide" on policy, but take things meeting by meeting, dependent on the data.
 
This was a signal that had done enough:  time to sit back and watch.
 
Then the data changed, dramatically, the same day.
 
The Senate voted to approve the Chips Act.  That was well telegraphed.  But then the controlling party of Congress surprisingly announced a reconciliation process to ram home the remainder needed to fund the "Build Back Better" agenda.  In total, by late afternoon, the Fed was now looking at another $680 billion of new spending – poured on top of an inflation problem they thought they had a handle on.   
 
Then, the same day, the White House telegraphed Biden's intention to greenlight, by executive order, his plan to cancel student debt. That's potentially another half a trillion-dollars of consumer liabilities that could be turned into consumption. 
 
So, the Fed was forced to, not only quickly walk back on the "neutral" proclamation, but they went on full verbal attack on jobs and the economy (and therefore, inflation) over the next month.  Stocks took another, deeper plunge.  
 
So, fast forward a few months, and by November a Federal judge had struck down the student loan plan as unlawful.  That was good news for the inflation picture. 
 
Now the decision sits with the Supreme Court, and reports from AP tonight suggest they will rule against it.  Bad news if you were hoping to have your liabilities wiped clean.  Good news if you want a chance at stable inflation and strong economic growth.
 
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Pro Perspectives 2/27/23

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February 27, 2023
 
As we discussed on Friday, we need a period of controlled hot inflation, as long as it comes with hot nominal economic growth.
 
Why?
 
The government debt has doubled, relative to the size of the economy since the Great Financial Crisis.
 
As you can see, this is Great Depression/World War II level debt.  
The only solution:  It has to be inflated away.  That has to come through hot nominal growth.
 
With that in mind, a boom-time period in GROWTH is way overdue.  
 
Remember, we’ve looked at this next chart many times throughout the history of my daily Pro Perspectives notes … 
 
In my chart, the blue line is the path of real GDP IF it had continued to grow at the long-term average rate of 3.8% (that’s the average growth rate from 1929).
 
So, if the economy had continued to grow “on trend” we would have a $26 trillion economy (the blue line). 
 
Instead, we had the Great Recession.  And instead of having the big bounce back in growth, that is typical following recessions, we had dangerously shallow and slow growth for the better part of a decade.  And that growth was only due to the Fed propping the economy up through continued ultra-low rates and QE. 
 
With that, the economy was knocked off (trend) path fifteen years ago, and the gap between trend and actual growth has only widened.  We have an economy $6 trillion smaller than it would be had we stayed on trend. 
 
This gap (between trend and actual GDP), and the (already) ballooned debt-load, explains why the Treasury (under Mnuchin) and the Fed (under Powell) didn’t hesitate to go big and bold to respond to the Covid shutdown.  It was an excuse to do what had to be done — inflate.
 
Of course, the politicos are opportunists, and they’ve taken advantage of crisis, pushing what was “big and bold” into “wild excess” (to fund their agenda).
 
With the damage from wildly excessive spending, the Fed’s challenge has been to take the threat of hyper-inflation off the table, but leave the economy with stable, but hotter than average inflation.  They may have done the job, but they will have to continue maneuvering/manipulating along the way. 
 
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Pro Perspectives 2/24/23

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February 24, 2023
 
Inflation cooled in Q4.  And it has bounced back in the first month of the New Year.
 
Following another inflation reading this morning, stocks traded down, and we end the week with some big technical levels tested. Let’s take a look at the chart …
First, as you can see, this steep decline of the past seven trading days started with the hot inflation report on February 14th (CPI). 
 
And today we got the last major inflation reading from the month of January (core PCE), and the stock market traded down toward the big trendline that describes the bear market of last year (the yellow line).  Moreover, it (the S&P futures) traded perfectly into the 200-day moving average (the purple line). 
 
These are two significant technical levels – formerly technical resistance, is now technical support.  So, into the 200-day moving average, stocks bounced.
 
Now, importantly, despite the hotter January inflation data, we’re not getting the type of reactionary tough talk from the Fed, that we had last year.  Why?  Because they are in control.
 
As Jamie Dimon said yesterday, the Fed “lost control” of inflation for a bit.
 
When he says inflation, he means inflation expectations.  
 
You can see it in this chart …
As we’ve discussed throughout this runup in prices, what the Fed fears more than inflation itself, is consumer (and business) inflation expectations.
 
If you expect higher prices, you might behave in ways that lead to higher prices (and potentially runaway inflation).
 
Back in April of last year (as you can see in the chart), that threat was materializing. 
 
But now, look to the far right of the chart, inflation expectations are tame, and well under control.  
 
So, where does the Fed go from here?  Again, despite hotter prices in January, we haven’t heard the reactionary tough talk (i.e. threats against markets and the economy) from the Fed this time. 
 
To the contrary, two Fed Presidents and the CEO of the country’s largest bank all used the word “little” to describe how much higher rates will go from here.  Bottom line, the rate path expectation that has been built into markets (and the economy) haven’t changed with the latest inflation data. 
 
And don’t forget, the Fed needs inflation, while under control, to run hotter than average for a bit longer. 
 
Remember, back in September of 2020, Jerome Powell made an official policy change in the way they evaluate their two percent inflation target.  Because inflation had been too low, for too long he told us he would let inflation run hot, to bring inflation back to 2% on average over time.
Inflation has run hot.  But as can see, if we take the average over the past fifteen years (post-Lehman) inflation remains below the Fed’s two percent target.
 
That’s good.  Remember, we’ve fired a lot of fiscal bullets over the past fifteen years.  And government debt has ballooned, as a result. 
 
We need a period of controlled hotter inflation, as long as it comes with hot nominal economic growth.  On that note, the economy has been growing at a nominal (including inflation) 9% pace since late summer of 2020 (average quarterly annualized GDP growth).
 
With the above in mind, the absolute value of government debt doesn’t mean much.  The debt relative to the size of the economy is what matters.  As you can see in the chart below, debt has doubled, relative to the size of the economy since the Great Financial Crisis.  
 
It now has to be inflated away.  That comes through hot nominal growth.  And growth is beginning to chip away at the debt, but not fast enough. 
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Pro Perspectives 2/23/23

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February 23, 2023
 
Tomorrow morning we'll get core PCE.  This is the Fed's favored inflation gauge (of particular interest, the monthly change from December to January). 
 
On that note, what's most important for markets, isn't the number, but the expectations.  And given the other inflation data we've already seen for January, expectations are already well entrenched for a hot number.  With that built in expectation, the chances of a negative surprise are dramatically reduced (i.e. negative surprise = surprisingly high inflation).  
 
Add to that, the Fed has clearly telegraphed an intent to do a few more quarter point rate hikes.  So, there is little-to-no chance that tomorrow's inflation data would induce a negative surprise on that front (i.e. negative surprise = a higher peak Fed Funds rate).
 
So, if anything, the set of potential outcomes skews toward a positive surprise for markets.
 
What also is setting up for a positive surprise?
 
The economy. 
 
We heard from Jamie Dimon again today.   This is the CEO of JP Morgan, the biggest bank in the country.  No one has more information on the health and trends of consumer and business behavior.  With that position of power, he also has a seat at the table with the Fed chair and White House economic advisors, as a member of the "President's Working Group on Financial Markets."  He knows things.
 
Back in January, just before Q4 earnings season kicked off, Dimon said 

the consumer is still strong, balance sheets are in good shape, and "they are spending more than pre-covid."
 
A day later, the big four banks reported earnings.  Adding back the war chest of profits they set aside (in the name of "loan loss reserves"), all four of the biggest four banks in the country would have beat earnings estimates, AND improved on the earnings from the same period a year ago.  

 
What did Jamie Dimon have to say today?
 
He said the economy is doing "quite well."  And he reminded everyone, that there has been a sea change in the economy.  With some context of his interview, he's talking about the transformation from a low inflation, low growth environment, to a government spending-fueled high growth, higher inflation environment, with (his words) a "normalization of interest rates."
 
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Pro Perspectives 2/22/23

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February 22, 2023
 
The minutes from the February Fed meeting were released this afternoon.  Stocks went lower. 
 
Remember, some important things happened at this meeting.
 
But forget the minutes, let's look back at the message the Fed sent, in real time, back on February 1st. 
 
>They downshifted to a quarter-point rate hike, from an aggressive streak of big hikes.
 
>More importantly, with this quarter-point, they took the Fed Funds rate ABOVE the rate of inflation (the annual change in the Fed favored core PCE index).
 
>And as importantly, the Fed Chair, Jerome Powell, followed that meeting with a press conference that had clear change in tone. 
 
"Out" was the tough talk.  And "in" was acknowledgement of the ground that has been covered, the disinflation in the economy, the goal of "real rates" reached.
 
Add to all of this, after spending the better part of the past year, talking markets down (and therefore tightening financial conditions), he made no attempt to do so in the February post-meeting Q&A session.  Keep in mind, stocks had just rallied nearly 10% rally in stocks over the prior month.
 
And make no mistake, talking down stocks (destroying paper wealth and confidence) and threatening job security (proclaiming to bring job openings down to align with job seekers) were key parts of the Fed's "forward guidance" strategy.  And it was, indeed, effective in crushing the exuberance in the economy, and therefore, turning the inflation tide. 
 
Again, Powell didn't find a problem with easing financial conditions at this Feb 1 press conference.
 
All of the above was the real-time message from the Fed (with clear intent) following the February 1 meeting.  That outweighs the Fed minutes delivered today.
 
Additionally, this morning, just hours before the release of these minutes, the most hawkish voice on the Fed, James Bullard, echoed the Jerome Powell tone change.  He said the economy is strong, the job market is strong, and he did nothing to change the path he has projected for rates (they have "a little ways to go"). 
 
And he said this:
 
"In the age of forward guidance, economic lags make less sense now."
 
Translation:  The market and the economy have already priced in the inflation fight (i.e. the bear market and economic recession — it already happened, last year). 

Pro Perspectives 2/21/23

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February 21, 2023
 
The Fed's favored gauge of inflation is core PCE (personal consumption expenditures).  It measures the change in prices of goods and services that people have actually paid — not just a selling price. "Core," means excluding food and energy prices. 
 
The January report on core PCE will come Friday.
 
As you can see in this chart, year-over-year Core PCE has been trending lower since last summer. 
That said, we already know from the CPI data last week, that price pressures were hot in January, compared to December.  We should expect a similar message from Friday's core PCE.  
 
So, the question: Is January a signal for what's coming (i.e. a strong bounce back in inflation)?  
 
Take a look at used car prices.  Used car prices topped out in January of last year, and bottomed in November.  Year-to-date this index is already up 7%.  
With the hot price data we've already seen from January, yields are on the move.  
 
The 10-year yield traded to 3.96% today.  That's up from 3.33% just earlier this month. 
 
This move in yields (higher) is triggering some fear in the stock market.  Stocks are down almost 4% in three trading days.  The VIX is up to the highest levels since the beginning of the year.  
 
Is this move in the bond market (yields higher), a signal to the stock market that the Fed might return to it's game of a year ago, where it put a strangle hold on the economy (and consumer confidence)?
 
If so, yields would be going the other way (lower). 
 
The bond market would be pricing in an even deeper and uglier recession, in the form of an even steeper inversion of the yield curve (an historic predictor of recession).
 
That's not happening.  The yield curve (2s/10s) is little changed from the beginning of the month. 
 
What is happening?  Contrary to the consensus view that recession is looming, we're seeing no signs that the economy is faltering (quite the opposite).  
 
The bounce back in economic activity in January has been strong.
 
Despite the Fed's best efforts, the job market remains tight.  And with the resilience of the job market, a sense of job security is good for confidence.  With that, confidence is coming back from record low levels of the early 80s.
 
And as we've discussed, the Fed has now taken the Fed Funds rate ABOVE the rate of inflation (it's favored gauge, core PCE).  That's historically where the Fed has gone to get inflation under control.
 
Meanwhile, they've normalized interest rates, and the economy is (still) on pace to put up another (consecutive) 2.5%+ growth quarter.    
 
Perhaps the bond market is beginning to price OUT recession (and a flattening of the yield curve). 

Pro Perspectives 2/16/23

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February 15, 2023
 
As we discussed yesterday, contrary to the consensus Wall Street view coming into the year, we're a month and a half in, and no signs of the economy faltering.
 
In fact, it's the opposite.  Here's a look at Citibank's index that measures surprises in the economic data (relative to consensus expectations)…
The bounce back in economic activity in January has been strong.  Despite the Fed's best efforts, the job market remains tight.  And with the resilience of the job market, a sense of job security is good for confidence.  With that, confidence is coming back from record low levels of the early 80s ….
This has come with hotter prices in January (both consumer prices and producer prices).  And hotter prices, combined with positive surprises in economic data has put a fire under yields, finally.
The purple line in this chart is the 10-year yield. This is the benchmark market-determined interest rate, which is the basis for setting many consumer rates. 
 
As you can see, market interest rates (purple line) have moved in the opposite direction of the Fed (orange line), through the past few rate hikes.  So, as the Fed was (and still is) projecting 5.1% as the ultimate stopping point for the Fed Funds rate, the 10-year has traded as low as 3.32% over the past month.  
 
Keep in mind, as the bond king, Bill Gross, has pointed out, historically the 10-year yield trades, on average, 90 basis points ABOVE the Fed Funds rate.  On that note, the bond market is thought to be the "smart money."  Does that mean it's right on the recession forecast?  
 
If the bond market were that "smart" why didn't the 10-year yield trade north of 9% when inflation was brewing in 2021?  
 
Why?  Because the government bond markets have been highly manipulated by central banks, globally — suppressing market interest rates.  It's safe to assume that's the only reason, at this stage, the benchmark 10-year yield trades in this 3%-4% range.   

Pro Perspectives 2/15/23

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February 15, 2023
 
Remember, going back to 1950, there has never been a 12-month period, following a midterm election, in which stocks were down. And the average one-year return following the eighteen midterm elections of the past seventy years was 15% (about double the long-term average return of the S&P 500).
 
That said, we came into the year with a lot of negative expectations priced into markets (from the rate path, to earnings erosion, to recession).
 
On the rate path, Jay Powell has since signaled in recent weeks that the end is near, if not here.  On earnings, we're about three-quarters of the way through fourth quarter earnings, and 69% of companies have beat estimates (not far from the 10-year average), and the contraction in S&P 500 earnings overall is in-line with expectations.  As for recession, the consensus view coming into the year questioned not "if," but "how severe" it will be.  So far, no signs of the economy faltering (quite the opposite). 
 
And keep in mind, we've already had a technical recession (in Q1 and Q2 of last year), in reaction to high inflation, and in anticipation of higher interest rates.  We've since had a 3.2% annualized growth quarter in Q3, a 2.9% quarter in Q4, and thus far, the Atlanta Fed model is projecting 2.4% for Q1 of this year. 
 
And as we discussed in my January 26th note (here), we are in a hot economy, where demand has been throttled by the Fed.  It's a not a sputtering economy with a demand problem.  Today's retail sales number supports that:  up 3% on the month.  Excluding the covid period, that is the hottest month in over 20 years.
 
As I've said, the Fed is holding the beach ball under water.  As they back off, we need the economy to boom, and for the wage level-to-price level gap to start closing (to restore standard of living).  

Pro Perspectives 2/14/23

Pro Perspectives 2/14/23

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February 14, 2023
 
We had the January inflation report this morning.  Prices rose at the hottest rate in several months, from December to January.  But the year-over-year inflation number came down. 
 
Remember, this inflation report has caused extraordinary swings in stocks for the better part of the past six months.  What happened today?  Nothing extraordinary.
 
Why? 
 
As we discussed yesterday: 
 
1) The headline inflation number is still high, but it doesn't reflect the current price pressures, because it's a calculation that measures the January CPI index against the very low base of January 2022.  We should expect the number to be high for a few more months. 
 
2) The Fed has already taken short term rates ABOVE the its favored inflation gauge (core PCE, which measures what consumers are actually paying for goods and services, less food and energy).  This "positive real rate" dynamic (where interest rates are above inflation) has historically proven to contain inflation and produce macroeconomic stability. 
 
3) The Fed has already built in market expectations for a few more hikes, so there was little-to-no risk of a change in that view, after seeing today's report.
 
Bottom line:  The Fed has been THE burden on the economy for the better part of the past year.  But Jerome Powell has given us plenty of signals the past two weeks, that the Fed has finished the job on the inflation fight (if not finished, then very near).  Nothing in this January inflation report should alter that position.