October 2022 Macro Commentary
INFLATION BLUES
On Friday, 10/7, the Labor Department reported that employers added 263,000 jobs in September on a seasonally adjusted basis. That was down from 315,000 in August. The unemployment rate fell to 3.5 percent from 3.7 percent a month earlier. Employers added 315,000 jobs in August and 526,000 jobs in July. More importantly, we have fully recovered all of the jobs lost during the opening months of the COVID-19 pandemic. This tight labor market indicates that there is still a great deal of room for the Fed to feel comfortable raising rates.
Recently on CNBC, Harvard Professor Kenneth Rogoff (credited with describing highly relevant aspects of the 2008 financial institution near-meltdown) says we need at least a 4.5% Fed funds rate to tame inflation. Then there's Paul Krugman from Princeton, an intellectual gadfly promoting (through his NYT graph-filled Op-Ed pieces) sketchy advice. His latest 10/5 quip "… it's hard to see anything that will cause the natural rate to rise once the inflation spike is over. So, the era of low-interest rates probably isn't over after all." It's not a spike, Paul, it's endemic, and the 15-year bacchanal of low-interest rates is over.
Finally, the savvy BB King (RIP) lets us know how he feels with his Inflation Blues ballad of 1983. It applies to working families today.
"Hey, Mr. President
All your members of Congress too
You got me frustrated
And I don't know what to do
I'm trying to make a living
I can't save a cent
It takes all of my money
To eat and pay my rent…
He had it right. Food and housing are not going down. In addition, the OPEC+ cartel led by Saudi Arabia and Russia agreed to lower production targets by 2mn barrels daily, or roughly 2 percent of global oil consumption. So much for the Biden -MBS fist bump. Brent crude quickly reached $98.45 a barrel. Please don't count on gas prices mitigating CPI in the coming months, as we could easily approach $5/gal this winter.
The reality is that what happens outside our borders will affect our economy. Global warming, i.e., man-made global warming, does not respect borders, and the largest land war since WW2 has strong inflationary repercussions. Neither is going away.
History shows that inflation takes an average of 10 years to return to 2% once it breaks above 5%, according to Thanos Vamvakidis1, a strategist for BofA Securities in the U.K. That's based on decades worth of data across advanced countries - something that no CNBC pundit has even attempted to do.
What else are we missing? According to Treasury Department data, the nation's total public debt outstanding closed at $31.1 trillion last week2. With "persistently rising" debt, investors could "lose confidence in the federal government's ability to pay off its debt, which could result in interest rates or inflation suddenly rising," according to the CBO.
Recently, Bloomberg reported that House prices in July and August posted their most significant monthly declines in more than a decade amid sky-high mortgage rates. Prices remain much higher than in 2019, having increased a whopping 45%. As mortgage rates continue to increase along with inflation, more people are being pushed out of the housing market, spelling bad news for sellers. Still, even a 20% drop in real estate will in no way retrace prices in any meaningful way to make homes more affordable for most American families. In addition, there is no relief in the rental markets in any of the 100 largest markets. How often have we heard a homeowner say: "I can't afford to buy my house today."
How about autos? Another large consumer purchase. OEMs and dealers have less incentive to take steps to bring down costs because demand is still vastly greater than supply, and given that the average age of an American car on the road is 13.1 years, that demand will only increase.
Consumers are still sitting on a mountain of excess savings — the extra cash consumers have piled up since February 2020. In fact, according to Wells Fargo, consumers have accumulated as much as $2.1 trillion in excess savings during this period. That's a lot of extra spending power in an economy with a $25 trillion annual GDP.
For most of this year, the financial markets have been indicating that inflation will revert to pre-pandemic norms and that the Fed will pivot in 2023. Those who thought they had their finger on the pulse of the market suffered significant losses this year.
Yet by simply looking back to 1973 (history is hard to escape), financial markets research firm Bianco Research notes the Fed had never stopped hiking before interest rates surpassed the Consumer Price Index (CPI). The chart below highlights this data. If our CNBC and Bloomberg pundits were to do just an iota of research, they wouldn't be giving such bad advice. Sadly, the retail investor and an overwhelming number of RIA's keep tuning in.
Source: Bianco Research
The earlier policy errors of the Fed - pumping trillions of dollars into the hand of U.S. consumers, thus laying the groundwork for long term inflation, and then refusing to quickly act when it became abundantly clear that this was the case - will continue to drive global pain and suffering for the foreseeable future.
We have a long way to go to compensate for our past fiscal and monetary indulgences. The road to redemption will take many years, and investors must have advisors that know how to protect them, not comfort them.
George Lucaci
Global Head of Distribution
908 723 3372 cell
Footnotes:
1 Fed's tough task: History shows inflation takes an average of 10 years to return to 2%.
2 Jennifer A. B. on LinkedIn: U.S. national debt nears $31T: What it means ....
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