After years of trying to move inflation higher (the elusive 2% inflation goal), the Fed’s ultra-easy QE policies along with plenty of help from the fiscal side (“helicopter” money, and outsized fiscal deficits) have more than accomplished the goal. Overshoot is an understatement! The financial media tells us every day that inflation is at a 40-year high with a seeming majority believing a return of the 1970s, years of ingrained high inflation levels, is at hand.
That Unpopular “T” Word
Much of the current spate of inflation is a function of supply chain bottlenecks, service sector personnel issues, “helicopter” money, and corporate greed – all of which are transitory (to use the unpopular term).
Supply Chains: Supply chains are still somewhat strained. Toyota has announced an output reduction as some of its Japanese factories due to continued chip shortages, and Samsung and Micron have indicated there will be output cuts due to recent Chinese closures of omicron infected areas (Xi’an). While certainly of concern, most of the news from the supply side has been upbeat, but we should be cognizant that the pandemic is not over and flare ups may further constrain supply. Nevertheless, here is the better news:
- Congestion at the two California major ports has improved, and since they are now working 24/7, it appears that “normal” may return by the end of February.
- U.S. ISM Manufacturing Survey shows order backlogs at an index level of 61.9 (November). While still high by historical standards, this has moved down from May’s all-time high of 70.6.
- Taiwan, So. Korea, and Vietnam, major chip manufacturers, have all experienced the lowest delays in six months. The same was true for China prior to the latest Covid lockdowns.
It should be noted that this picture could change abruptly depending on reactions from production factors and governments to omicron or other upcoming Covid variants. For example, the recent Chinese lockdown of the city of Xi’an (13 million population) are not yet in the data.
Service Sector: The financial media reports the rapid wage hikes in some of the service sectors as if they are economy wide. The latest Atlanta Fed Wage Tracker pinpoints the escalating wage issues to the lower educated and unskilled (mainly younger) in the services sector which is responsible for about 20% of the workforce. The other 80%? Not Much! (See the self-explanatory chart at the top.)
Service Sector Personnel Issues: Pre-omicron, service sectors like restaurants and airlines were re-approaching 2019 levels of activity. Omicron has had an impact, with Open Table reporting falling restaurant bookings and havoc occurring with airline schedules (cancellations) over the Christmas holiday weekend. However, with a majority of schools back to students in the classroom, many working mothers have begun to return to the workforce. We saw in the November jobs data that the Labor Force Participation Rate for young females rose, and we expect December’s numbers to continue to show such gains.
“Helicopter” Money: Much of current inflation has been caused by the policies of giving out free money of both the Trump and Biden Administrations. A simple example: A worker in a widget factory makes one widget per day. If laid off, the widget isn’t produced, but the worker has no income. Both supply and demand have fallen. By the government giving away free money, the widget didn’t get produced, but the worker still had income, and demand remained. The government produced demand/supply imbalance created inflation. That has now gone away. The last of the helicopter money went out in December in the form of “child care” tax credit payments (which are really pulled forward from 2021 taxes due next April!). Without “free money,” 2022’s growth rate will be impacted!
Corporate Greed: There have been reports of corporations taking advantage of the “inflation narrative” and raising prices (read: “profit margins”) at a faster rate than the cost of inputs because they know customers, having been saturated by the media with the “shortage” narrative, would not object, apparently happy to have product available at all. This is a problem that is solved by “competition” in a capitalistic economy.
Thus, it appears that , while inflation may be elevated for a couple more quarters, it ultimately will prove to be “transitory” in the sense of “not permanent” or “long-lasting.” (The term “transitory” appears to have gotten a bad name because of the need for “instant gratification” now imbued in U.S. culture.)
In past blogs, we have chronicled why we think that growth will disappoint, including:
- Inflation reducing real incomes;
- Weaker than perceived consumption due to seasonal adjustment factors biasing October and November Retail Sales to the upside as the “shortage” narrative pulled holiday shopping forward;
- A recent uptick in layoffs (see chart);
- The Chicago Fed’s National Activity Index for November falling to half its October level;
- The Baltic Dry Index, an index of the cost of shipping bulk commodities, falling more than -60% from its most recent peak, likely due to flagging Chinese demand.
The latest data include:
- A record trade deficit – not just higher, but way way higher ($97.8 billion in November vs $83.2 billion in October; consensus was $88.1 billion!). Exports fell -2.2% as foreign demand slowed (slower growth worldwide, especially China) while imports rose +4.7% (where are the “shortages?”). 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 Homes Sales are a leading indicator for the housing industry – these are new contracts signed as opposed to Existing Home Sales which are closings (which occur two to three months after contracts are signed). As has been the trend for the past few months, the consensus missed to the high side (+0.8%). Pending Sales have now fallen in two of the last three months and in four of the last six. Perhaps skyrocketing prices are to blame! It is likely that a continuation of the the trend of falling 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 are rising due to an increasingly hawkish Fed while long-term rates are holding steady as the economic outlook softens. An “inverted” yield curve (short-term rates higher than long-term) has always resulted in recession. While we are still not there, a flattening yield curve serves as a first warning.
Equity: We end the year with the equity markets at or near record highs. But, under the hood, not all is healthy. Economist David Rosenberg points out that one-third of the stocks in the Nasdaq are 50% lower than their 200-day moving averages, and that over the past eight months, five stocks (AAPL, GOOGL, NVDA, TSLA, and MSFT) have accounted for half the S&P 500’s total return. In addition, he points out that mutual fund redemptions and sales of ETFs have markedly increased of late.
History tells us that stocks take a breather, especially after three years of significant double-digit returns. The Fed has taken its first baby tightening steps with hasher moves scheduled for 2022. Equities usually react poorly to Fed tightenings, and this time, to compound the issue, the Fed will be tightening into a slowing economy (if, indeed, it follows through). History also tells us that, under such circumstances, a soft landing is highly unlikely.
As we pen this, 2022 is just a day away. We don’t know the future. Perhaps inflation quells before the first rate hike and/or the omicron is less virulent, passes quickly, no new variant emerges, and the pandemic passes (wishes do, sometimes come true, but not often!). But, back to Earth! We really must go with the odds which say:
- Indexed equity returns are likely to be soft for several quarters.
- A correction of length and significance depends on Fed policies; an unknown at this time, so best to be conservative and assume the Fed will raise rates beginning in the next few months.
- A flattening yield curve is not a positive for economic growth. While short-term rates may rise due to Fed policies, longer-term rates are sensitive to economic growth – so our forecast remains “lower for longer.”
Ultimately, inflation and economic growth are most influenced by long-term factors like demographics, debt, and technology (DDT). Short-term issues like “helicopter money,” government business mandates, and gargantuan federal deficits can influence economic growth. But as we have learned once again, unwanted and growth killing inflation results from such actions. Under current economic conditions, and with current economic policies and consumer attitudes, “disappointing” economic growth looks to be the most likely outcome for 2022’s economy.
Robert Barone, Ph.D.
(Joshua Barone contributed to this blog.)