After years of trying to push up inflation (the elusive 2% inflation target), the Fed’s super-easy quantitative easing policies as well as plentiful help from the budget side (‘helicopter’ money) and disproportionate budget deficits) more than met the target. . To go past is an understatement! The financial media tell us every day that inflation is at its highest level in 40 years and that an apparent majority believe a return to the 1970s, years of entrenched high inflation levels, is within reach. .
This unpopular “T” word
Much of the current wave of inflation is due to supply chain bottlenecks, staffing issues in the service sector, ‘helicopter’ money and corporate greed – all of which are transient (to use the unpopular term).
Supply chains: Supply chains are still somewhat strained. Toyota has announced a cut in production as some of its Japanese factories due to continued chip shortages, and Samsung and Micron have indicated that there will be production cuts due to recent Chinese closures of areas infected with the virus. omicron (Xi’an). While certainly concerning, most of the news on the supply side has been bullish, but we need to be aware that the pandemic is not over and that flare-ups could restrict supply further. Still, here’s the best news:
- Congestion at California’s two main ports has improved, and with they’re now operating 24/7, it looks like “normal” could return by the end of February.
- The US ISM manufacturing survey shows order books at an index level of 61.9 (November). While still high by historical standards, that number has fallen from the all-time high of 70.6 reached in May.
- Taiwan, then. Korea and Vietnam, the major chipmakers, all experienced the smallest delays in six months. The same was true for China before the latest Covid lockdowns.
It should be noted that this picture could change abruptly depending on the reactions of factors of production and governments to omicron or other upcoming variants of Covid. For example, the recent Chinese lockdown of the city of Xi’an (13 million people) is not yet in the data.
Service sector: The financial media report rapid wage increases in some service sectors as if they affected the economy as a whole. The latest Atlanta Fed Wage Tracker highlights escalating wage issues for less educated and unskilled people (mostly younger people) in the service sector, which makes up around 20% of the workforce. The remaining 80%? Not a lot! (See the explicit table above.)
Staff issues in the service sector: Pre-omicron, service sectors like restaurants and airlines were approaching 2019 activity levels. Omicron had an impact, with Open Table reporting a drop in restaurant reservations and wreaking havoc on airline schedules ( cancellations) during the Christmas holiday weekend. However, with a majority of schools returning to the classroom, many working mothers have started to return to the workforce. We saw in the employment data for November that the participation rate for young women has increased, and we expect the numbers for December to continue showing such gains.
“Helicopter” money: Much of the current inflation has been caused by the free money distribution policies of the Trump and Biden administrations. A simple example: an employee of a widget factory makes one widget per day. If laid off, the widget is not produced, but the worker has no income. Both supply and demand have declined. By the government giving free money, the gadget was not produced, but the worker still had an income and the demand remained. The government produced an imbalance between supply and demand and created inflation. It is now gone. The last of the helicopter’s money came out in December in the form of âchild careâ tax credit payments (which are really pulled ahead of the 2021 taxes due next April!). Without “free money”, the growth rate of 2022 will be impacted!
Corporate greed: There have been reports of companies taking advantage of the “inflation narrative” and raising prices (read: “profit margins”) at a faster rate than the cost of inputs because they know the customers, having been saturated by the media with the narrative “shortage”, would not object, apparently happy to have a product available. It is a problem which is solved by “competition” in a capitalist economy.
Thus, it appears that although inflation may be high for a few more quarters, it will ultimately prove to be “transient” in the sense of “non-permanent” or “long-lasting”. (The term “transient” seems to get a bad rap due to the need for “instant gratification” now entrenched in American culture.)
In previous blogs, we’ve covered why we think the growth is going to disappoint, including:
- Inflation reduces real incomes;
- Weaker than perceived consumption due to seasonal adjustment factors skewing October and November retail sales upward as the âshortageâ narrative pushed holiday shopping forward;
- A recent increase in layoffs (see graph);
- Chicago Fed’s national activity index for November drops to half its October level;
- The Baltic Dry Index, an index of the cost of shipping bulk goods, has fallen more than -60% from its most recent high, likely due to weakening demand from China.
The latest data includes:
- A record trade deficit – not only higher, but much higher ($ 97.8 billion in November compared to $ 83.2 billion in October; the consensus was $ 88.1 billion!). Exports fell by -2.2% with the slowdown in foreign demand (slower growth in the world, especially in China) while imports increased by + 4.7% (where are the âshortages?â) . This will be a huge subtraction for Q4 GDP, especially if December is a repeat, which we believe is a realistic assumption.
- Pending home sales fell -2.2% M / M in November. Pending home sales are a leading indicator for the housing industry – they are New contracts msign as opposed to Sales of Existing Houses which are closings (which take place two to three months after the signing of contracts). Like the trend of the last few months, the consensus has missed the top (+ 0.8%). Pending sales have now fallen in two of the past three months and four of the past six. Perhaps the surge in prices is to blame! It is likely that a continuation of the downward trend in demand will stop or even reverse the price trend. If so, once again we will see that the cure for high prices is high prices!
Fixed income: The yield curve has flattened – short-term interest rates rise due to an increasingly hawkish Fed while long-term rates hold up as the economic outlook eases. An âinvertedâ yield curve (higher short-term than long-term rates) has always resulted in a recession. While we’re not there yet, the flattening of the yield curve serves as a first warning.
Equity: We end the year with equity markets at or near record levels. But, under the hood, all is not healthy. Economist David Rosenberg points out that a third of Nasdaq shares
History tells us stocks are taking a hiatus, especially after three years of strong double-digit returns. The Fed has taken its first baby-tightening action with hash moves slated for 2022. Stocks generally react poorly to Fed tightening, and this time, to make the problem worse, the Fed will tighten in a slowing economy ( if, indeed, it continues through). History also teaches us that under such circumstances a soft landing is highly unlikely.
As of this writing, 2022 is just one day away. We don’t know the future. Perhaps inflation is choking before the first-order hike and / or the omicron is less virulent, passes quickly, no new variants emerge, and the pandemic passes (wishes sometimes come true, but not often !). But back to Earth! You really have to go with the odds that say:
- Indexed stock returns are expected to be low for several quarters.
- A correction of length and importance depends on the policies of the Fed; an unknown at the moment, so it is best to be cautious and assume that the Fed will raise rates from the next few months.
- A flattening yield curve is not positive for economic growth. While short-term rates may rise as a result of Fed policies, long-term rates are sensitive to economic growth – so our forecast remains “lower for longer.”
Ultimately, inflation and economic growth are primarily influenced by long-term factors such as demographics, debt, and technology (DDT). Short-term issues like “helicopter money”, government trade mandates and gargantuan federal deficits can influence economic growth. But as we have learned once again, unwanted, growth-killing inflation results from such actions. Under current economic conditions, and with current economic policies and consumer attitudes, âdisappointingâ economic growth appears to be the most likely outcome for the 2022 economy.
(Joshua Barone contributed to this blog.)