Trying to Puzzle Through the Current Macro Situation
Trying to Puzzle Through the Current Macro Situation
For the first time since 2009-2010, when I (mistakenly) believed that Bernanke at the Fed & Obama & the center of gravity of his advisors understood the seriousness of the situation & were about to...
For the first time since 2009-2010, when I (mistakenly) believed that Bernanke at the Fed & Obama & the center of gravity of his advisors understood the seriousness of the situation & were about to take appropriate action to rapidly restore full employment, my short-term macro forecasts are going sufficiently awry to make me suspect the reliability of my vision of the Cosmic All. Hence I am trying to think about this.
My current guesses? A 40% chance that things are simply delayed by the long and variable lags, a 30% chance that I am in for a big surprise as it turns out that that the era of “secular stagnation” & permanently low equilibrium rates that place chronic deflationary pressure on the economy, and a 30% chance the “unknown unknowns” rule everything around us…
On the job-growth side, the market expected the BLS March Employment Report released on Friday April 5 to show estimated seasonally-adjusted payroll-survey nonfarm employment growth around 210,000 in March (compared to 275,000 in February). On the inflation side, the market expected core CPI inflation in the report report released on Wednesday April 10 to be not inconsistent with continued downward pressure on officially-recorded inflation.
Neither of those things happened.
The CPI release told us that core CPI inflation continued at its previous level, with the one-month jump at an annualized rate of 4.4%. It is now very hard to avoid the conclusion that inflation kissed the Federal Reserve’s 2% core PCE-index concept in the second half of 2023, and now has taken a small uptick. The past six months’ core-PCE concept average annual inflation rate is now 2.9%—not far above the 2.0% target, but far enough above it to be noticed.
The Employment Report of April 5 told us that job growth around 210,000 in March was not what the market got. The market got a significantly stronger economy. What the market got was an estimated 303,000 increase in payroll-survey nonfarm employment, with job gains broad-based, plus a net-22,000 revision for January and February. That gave us in March an estimate of seasonally-adjusted payroll-survey employment 829,000 above the estimate as it stood in December. What the market got was household-survey unemployment rate at 3.8% staying in the narrow range of ±0.1%-point it has been in for 2/3 of a year. What the market got was a 26th straight month with the estimated unemployment rate below 4%: something not seen before in the working lives of anybody who is today less than eighty years old:
A pace of job growth around 210,000 in March would have been a solid pace, given a current average monthly increase in U.S.-born potential workers of 100,000 or so matched by an equal current average monthly increase in immigrant workers of the same magnitude. But that would not have been inconsistent with the Federal Reserve’s continuing to plan to cut interest rates in June if it had confidence that inflation was continuing to moderate.
But now the Federal Reserve does not have that confidence in continued inflation moderation. The Federal Reserve remains profoundly uncomfortable with interest rates substantially in excess of what it believes the neutral rate to be. I seriously doubt that even a small handful of FOMC members believe that today’s r* corresponds to a policy rate in the range 5.25-5.5%. But the Federal Reserve does not dare start to end this post-soft landing touchdown period of reverse thrust until it sees signs of reduced forward employment groundspeed, and signs that inflation moderation is stil in progress.
On the asset-markets side, the inversion of the yield curve tells us that the market has (and also the Federal Reserve has) for what is now a long time—since the start of August, 2022—held a strong belief that at the current levels of interest rates monetary policy is substantially restrictive. And the Fed and the market have both believed for what is now a long time—since the start of December, 2022—that a loosening of monetary policy will start within a year, as the Fed either tracks the curve or tries to recover after falling behind the curve. That year ended five months ago:
Interest rates continue at levels that nearly all analyses say are clearly restrictive. Financial conditions are relatively loose, but only due to a relatively fragile “AI” boom-bubble and a commercial real-estate crash right now being held in suspended animation. Lags in the collection of rental data will be putting substantial downward pressure on recorded inflation numbers over the next year. And while fiscal policy is still loose, I would not have judged at as sufficiently stimulative to offset restrictive monetary conditions.
Supply-chain healing and the rapid recovery of immigration have raised Federal Reserve expectations of trend growth. Those factors would have allowed it to square the circle of there having been no recession even though they believe policy is substantially restrictive, and allowed them to continue to believe that policy is substantially restrictive. Continued inflation declines in the past six months would have validated that judgment. That continued decline did not happen. Last January I wrote that “neither the Beveridge Curve nor fear that real-wage increases herald an imminent rebound to inflation” were solid foundations on which to build a forecast inconsistent with the idea that monetary policy was still restrictive. I was right: those considerations weren’t solid foundations. But inflation is definitely not still ticking down.
So what gives?
Maybe monetary policy is still restrictive. One scenario is the Wile E. Coyote scenario: that recession or near-recession is still coming, and that within a year the Federal Reserve will be frantically cutting interest rates as a bulk of the following happen:
Disappointing revenues from not AI-chip providers and not AI-cloud providers but rather AI-services providers cast the current tech boom into substantial doubt, and leads to a tightening of financial conditions.
The delay in Fed rate-cutting leads to the end of extend-and-pretend in commercial real estate, further tightening financial conditions.
The election of Donald Trump causes a collapse in expectations of continued pro-investment government policies, just because Trump policy is random.
The election of Donald Trump causes the US to launch a renewed batch of trade wars which it will again lose (not, mind you, that those we wage them against will win).
American consumers finish spending-down their asset accumulations from the COVID plague years.
Other sectors in addition to commercial real estate turn out to be financial houses of cards relying on permanent low interest rates for their sustainability.
Anticipated productivity growth has a perverse effect, as firms stop hiring in order to avoid future waves of firing workers—and the rising-unemployment multiplier comes into play.
The chance that this scenario will come to pass? Perhaps four in ten, all told.
Maybe monetary policy isn’t restrictive after all. A second scenario is that we are now emerging from the decade and more of secular stagnation, because:
The debt accumulations of fifteen years of government deficits have resolved the safe-asset shortage which had kept short-term Treasury interest rates very near their lower bound and greatly reduced central banks’ abilities to manage the economy.
Faster productivity growth from a high-pressure economy raises returns and investments and validates the current interest-rate configuration as high expected future profits from expansion drive investment ahead of savings.
The replacement of the crypto-bubble with an AI-boom in which scaling laws hold for long enough that the build-out of tech capital does produce some very useful and valuable use cases further amplifies productivity growth.
China shifts from its bankrupt real-estate and infrastructure growth model to a domestic consumption-oriented growth model.
The flow of private savings out of China—from those seeking insurance against being found by Xi Jinping to be enemies of the CCP—moderates.
In that case, we get back to the growth configuration we had in the Clinton years—the configuration that we thought then was permanent, but was thrown away as a consequence of the financial deregulation and tax-cut-for-the-rich moves of the Bush administration in the 2000s—and the future will look bright. The chance of this scenario? I guess it at 30%.
And the other 30%? Ah, there we get into the true plastromancy business, because those scenarios depend on unknown unknowns. There is no empirical regularity in the macroeconomy, no matter how well grounded in historical data, in statistical estimation, or in theoretical concepts, that can be trusted not to crumble beneath our feet in a remarkably short time. But what is crumbling now, and in what way?
For more than fifteen years I have been saying that the bond market will tell us when it is time to start worrying again about moving the federal budget closer to balance. It would certainly be prudent to have a current annual deficit of not $1.7 trillion a year—6% of GDP—but rather $800 billion—3% of GDP. But where is the legislative coalition for such a move?
References:
DeLong, J. Bradford. 2024. 2024. “Somewhat Alarmed at the Federal Reserve”. Grasping Reality. February 1. <https://braddelong.substack.com/p/somewhat-alarmed-at-the-federal-reserves>.
Federal Reserve Bank of St. Louis. 2024. “Consumer Price Index for All Urban Consumers: All Items Less Food & Energy in US City Average (CPILFESL)”. FRED. April 10. <https://fred.stlouisfed.org/series/CPILFESL#0>
Federal Reserve Bank of St. Louis. 2024. “Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis (DGS10)”. FRED. April 5, 2024. <https://fred.stlouisfed.org/series/DGS10#0>.
Federal Reserve Bank of St. Louis. 2024. “All Employees, Total Nonfarm (PAYEMS)”. FRED. April 5. <https://fred.stlouisfed.org/series/PAYEMS#0>.
U.S. Bureau of Labor Statistics. 2024. “The Employment Situation—February 2024”. April 5. <https://www.bls.gov/news.release/empsit.nr0.htm>.
What I want to know is how Jamie Dimon was suggesting we might have a return to 8% interest rates, and why he said this? Where did the implied inflation come from? Or was it increased defaults as risks increased?
Where has inflation been high of recently (Q3-Q4 in PCE)? Shelter, insurance (life, auto, & house), auto repair, dental services, and nursery school. Will interest rates rise induce us to consume less of any of these? Probably not and often hopefully not. Although higher interest rates have reduced housing construction permits, thereby constraining the supply of shelter which is already in shortage, in which case rate cuts may exacerbate shelter inflation. Should the Fed raise interest rates to combat the cost of climate change on property insurance or the pandemic on life insurance?
Rate hikes seem best aimed at slowing bank credit growth that has stimulated consumption & investment faster than capacity. But both total bank credit and C&I have been flat for over 18 months. Meanwhile, private credit is flooding businesses. Does the Fed influence private credit through rate hikes, or do their hikes redirect credit growth to shadow banking which has a long and unknown lag?