How Long Will Inflation Stay High?
Business
We are all familiar with the famous T.S. Eliot quote of “Most of the evil in this world is done by people with good intentions.” And in complicated circumstances with incomplete information, we are often only left with the choice between the lesser evil of sub-optimal outcomes.
This inconvenient truth, blended with the conference board leading indicator x Chicago PMI numbers (see top chart below), possibly provides a background to the “less hawkish / dovish gradient” Fed statements this week. The outcome was a further rally in asset prices, which will not contribute to slowing down a secular inflation scenario via the reverse wealth effect.
At the same time, nonfarm payrolls again surprised to the upside (263k added, ignoring possible data issues) while trending down on a moving average basis. Similarly, nonfarm temporary help jobs trend downwards (some of the first to go as things turn bad), and the Challenger job cuts YoY had a massive jump (see middle chart below).
credit Bloomberg
Furthermore, this platform has a public employment report (December Workforce Report 2022), and it does not look better. In summary, the lag in employment slowdown looks to transmit itself on average to the broader economy, yet not fast.
In times like these, it is helpful to take a step back and evaluate whether certain asset price levels make sense using basic models. For example, the current UST 10y rate is in line with a simple slow-moving fair value model of real GDP growth, CPI, and employment gap (~3.5%, see bottom chart below). A similar approach for the SP500 via real GDP, corporate bond spreads, M1, and CPI paints a similar picture (~3950 in cash, not shown). As a result, from a macro coincidence point of view, equity and bond levels are not entirely out of line. To be clear again, apart from a smell test, the predictive power of these simplistic analyses is minimal, let alone should one not claim causal inference.
The wild card here is the sudden re-opening of the Chinese economy.
In conclusion, which brings us back to the beginning. If anything, this will not be deflationary. In combination with what the Fed is now possibly preparing to counter (deflation vs. disinflation) and subsequently considering slowing down hikes, we can then see a repeat of the 70’s double peak inflation in conjunction with a recession. These observations beget whether it is possible to maneuver such a complicated situation at all with only the blunt instrument of setting the short-term interest rate level.
Written by Mika Kastenholz
Business
How Long Will Inflation Stay High?
