Blind Leading the Blind
The Credit Strategist Blog
Jay Powell recently admitted that that Fed just learned how much it didn’t know about inflation, a stunning admission by the head of the most powerful central bank in the world. I hate to break it to Mr. Powell, but it wasn’t that difficult to know what to expect from trillions of dollars of monetary and fiscal stimulus that began long before the pandemic. And as long as real interest rates are deeply negative and the Fed believes the phony inflation numbers published by the government, we will continue to live in a world where the blind lead the blind.
But even the Fed can read headline inflation numbers of 8 percent, which is why it is desperately trying to slow economic growth. And there are signs it is starting to succeed. While headlines suggest this morning’s employment report was much stronger than expected, a deeper read shows it was mostly just a case of beating low expectations. The 372,000 June payroll increase was 107,000 higher than the consensus but mostly offset by a downward revision of the two previous months of 74,000. The household survey showed jobs falling by 315,000 and the unemployment rate only stayed at 3.6% because the labor force fell by 353,000. Not bad but nothing to write home about.
If we take a longer view, we see the jobs market slowing. The 3-month average payroll increase of 375,000 was down from the 6-month average of 457,000 and the 12-month average of 524,000. The full-year 2021 average was 562,000. We are clearly seeing a deceleration in jobs growth as the Fed tightens policy. But there was nothing in the June report that should deter the Fed from raising rates by 75 basis points later this month. That will still leave real (inflation-adjusted) rates deeply negative but will nonetheless exert further downward pressure on economic growth. But with real rates still negative, we are nowhere near the point of taming inflation and may not reach that point before the Fed bails. If/when the Fed massages the inflation number back to its target of 2%, nobody should believe that number remotely reflects the actual cost of goods and services in the real world. It is a fantasy constructed by the government to keep the inflation train rolling to impose its invisible tax on citizens to the end of time.
There are other signs that the economy is slowing as well. Commodity prices are dropping sharply from their recent highs – energy, metals and agricultural commodity prices fell meaningfully in recent weeks. Unfortunately, they remain elevated and well above pre-pandemic levels (with some exceptions). We should see further price declines over the rest of the summer as the economy grinds down a bit. Bond yields are also down from recent highs but with the Fed tightening it is hard to see how yields go lower absent a recession. Some very smart economists are calling for precisely that – a slowdown in inflation as the economy slows leading to lower yields over the rest of the year. If they are correct, that would be good for bonds but not for stocks.
Those economists are also forecasting an end to Fed tightening by December and a shift to easing shortly after that. As I wrote in the most recent issue of The Credit Strategist, such a reversal would be a colossal blunder. The obsession with avoiding a recession is misguided and another example of letting politics distort policy. Our economy needs a recession to purge the excesses of years of reckless monetary and fiscal spending. The Fed needs to return the Federal Funds rate to ~3% and leave it alone and shrink its balance sheet significantly. It needs to stop interfering in markets and the economy and let free markets set the price of money and the terms of trade. As long as Jay Powell & Co. don’t understand inflation (or much of anything else for that matter), they should do as little as possible to avoid doing more harm than they’ve already done.
Superb as always.