Is It Time to Worry About Deflation, and a Recession?

 Financial FAQs

 

CNBC

The Fed is beginning to ease its purchases of Treasury and Mortgage-backed securities in its push to raise interest rates and lower inflation, a policy called Quantitative Tightening (QT) as opposed to the various Quantitative Easing efforts (QE) when it wanted to boost inflation by increasing the money supply in 2009 at the end of the Great Recession.

But what if QT, accompanied by the Fed’s short term interest rate hikes—3 percent to date with its federal funds rate up to a range of 3%-3.25%, which is the highest it has been since early 2008—results in shrinking the money supply so much that it causes a recession, or worse?

It’s possible if the Fed continues to boost interest rates while the worldwide energy and food crunch, which is the real reason wholesale and retail prices have risen so fast, ends almost as quickly as it began.

The Fed would then have to reverse course for fear we might fall into a disinflationary spiral, or worse; deflation as Japan experienced in a decade of lost growth. QE enabled our recovery from the Great Recession, a recession almost as bad in terms of lost assets as the Great Depression.

I reported recently that economists such as Nobel Prize-Winner Joe Stiglitz are beginning to signal that possibility.

“Monetary policy typically affects economic performance with long and variable lags, especially in times of upheaval,” said Professor Stiglitz in a recent Project Syndicate article. “Given the depth of geopolitical, financial, and economic uncertainty – not least about the future course of inflation – the Fed would be wise to pause its rate hikes and wait until a more reliable assessment of the situation is possible.”

Some Wall Streeters are joining the chorus to slow down the rate increases. Cathie Wood, CEO of hedge fund Ark Invest, and a vocal proponent of deflation, is getting a few high-profile supporters even as price pressures continued to surprise to the upside, as reported by CNBC.

Jeffrey Gundlach and Elon Musk recently joined Wood’s camp in calling for a decline for prices, expressing worries that the Federal Reserve might go too far. Bond King Gundlach warned of the deflation risk on Tuesday, urging investors to buy long-term Treasurys. Meanwhile, the Tesla CEO called falling commodity prices “neither subtle nor secret” and tweeted to his 100 million followers that “a major Fed rate hike risks deflation.”

Wood has been warning about deflation since last year and is now doubling down on her call as several leading indicators she watches are pointing to deflationary forces instead of inflation, says CNBC.

““Leading inflation indicators like gold and copper are flagging the risk of deflation,” Wood said. “Even the oil price has dropped more than 35% from its peak, erasing most of the gain this year.” Gold prices have slid 6% so far this year. “Inflation is turning into deflation,” she said.

There was a real deflation danger in 2009 and a reason for QE. More precisely, the retail Consumer Price Index used to measure retail inflation had sunk to a minus -1.96 percent with little sign of rising after the shock of the Lehman Brothers collapse and possibility that many other firms on Wall Street were also in danger of collapse.

Congress and the GW Bush administration raised more than $700 billion to save the banks and Wall Street at the time, but it took years to raise the inflation rate back to 2 percent.

That’s our past history, which seems to put the Fed between a rock and a hard place, as the saying goes. Should it allow the inflation rate to continue to decline on its own, as it is doing, or speed up the process of decline, thus threatening a more severe downturn?

Yikes, what a situation to be in!

Harlan Green © 2022

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

Homebuyers on the Move Again

 The Mortgage Corner

FRED30yrfixed

Mortgage rates are on the march again, but so are homebuyers. How long must prospective homebuyers wait when average conforming 30-year fixed rates topped 6.29 percent this week per Freddie Mac and the Fed says they may push up rates even further?

Fixed conforming mortgage rates dropped below 5 percent for the first time in 2009, per the FRED graph that dates back to 1971, yet home buyers kept buying as the economy recovered from the Great Recession and busted housing bubble as well.

They are buying again after the big rise interest rates engineered by the Federal Reserve. Why is it such a surprise?? Rates are still low historically, though home prices have surged in the double digits because of the prolonged decline in interest rates during the pandemic.

One reason for the buying surge? “Most of the country saw modest improvements in homebuyer affordability for the third straight month because of slightly lower mortgage rates amidst steady income gain growth. The healthy labor market continues to be a positive for the housing market, despite ongoing economic uncertainty and high inflation,” said Edward Seiler, MBA's Associate Vice President, Housing Economics. “Higher mortgage rates have reduced borrowers’ purchasing power since the start of the year.”

MBA.org

Both purchase and refinance applications increased in the last week per the Mortgage Bankers Association indexes, up 1 percent and 10 percent, respectively. So-called Jumbo conforming rates were slightly better. For homes sold for over $647,200, the average rate for the 30-year was 5.79 percent. The 15-year rose to 5.56 percent.

The latest existing- home sales rate dropped slightly to 4.8 million annualized, which is actually on a par with average home sales since the Great Recession. It dipped below 4 million during the last two recessions. Whether home buying continues might depend on how much higher interest rates climb.

"The housing sector is the most sensitive to and experiences the most immediate impacts from the Federal Reserve's interest rate policy changes," said NAR Chief Economist Lawrence Yun. "The softness in home sales reflects this year's escalating mortgage rates. Nonetheless, homeowners are doing well with near nonexistent distressed property sales and home prices still higher than a year ago."

So, a housing recession may not be in the cards, just yet.

Harlan Green © 2022

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

What is the Real Inflation Problem?

 Financial FAQs

 

FREDppi

What is worse, inflation rates, say, of 4 to 5 percent—slightly above historical averages, and average gas prices maybe $3.50 per gallon as they are today—or raising short term rates enough to make consumers pay more and job losses mount?

That is essentially the devil’s bargain the Fed seems to be offering Americans by Fed Chair Powell insisting that, “Reducing inflation is likely to require a sustained period of below-trend growth,” in his speech to the central bankers and economists gathered at the base of the Grand Tetons.

As financial markets continue to plunge on fears that the Fed will slow down growth so much that it will induce a recession, economists such as Nobel Prize-winner Joseph Stiglitz are warning the Fed may go too far.

“Monetary policy typically affects economic performance with long and variable lags, especially in times of upheaval,” said Professor Stiglitz in a recent Project Syndicate article. “Given the depth of geopolitical, financial, and economic uncertainty – not least about the future course of inflation – the Fed would be wise to pause its rate hikes and wait until a more reliable assessment of the situation is possible.”

“There are several reasons to hold off," continues Stiglitz. "The first is simply that inflation has slowed sharply. Consumer price index (CPI) inflation – the measure most relevant to households – was zero in July, and it is likely to have been zero or even negative in August (was 0.1%). Similarly, the personal consumption expenditure (PCE) deflator – another often-used measure based on GDP accounts – fell by 0.1% in July.”

So, the Fed may be looking in the wrong direction (the 1970s) for the causes of inflation. Wages, which were considered the main culprit for rising prices in the 70s, aren’t rising as they did then; have in fact fallen 2.8 percent behind the latest inflation surge.

Why not look at the much more severe and temporary supply-chain disruptions; the Ukraine war, and China’s COVID lockdowns as the major cause for the inflation spike?

Wholesales prices are falling even faster—with the Producer Price Index (PPI) down -0.1 percent in August reported today. The increase in the core prices without the volatile food and energy prices over the past year also slowed to 5.6 percent from 5.8 percent.

It makes more sense that markets should wait for the PPI index to come out before passing judgement on the Consumer Price Index, since the PPI ingredients (such as raw material prices) will tell us how retail (CPI) prices are trending. But, no, financial markets work on the hair-trigger principle, are too impatient in the one-click digital markets with their herd mentality to wait another day for the PPI results.

Counterbalancing rising inflation is also the super-strong Dollar making import prices cheaper for consumers and industrial materials. The dollar index, which tracks the greenback against its peers, was up 1.5 percent at 109.85 in its biggest one-day percentage gain since March 2020 after the CPI report.

Market traders and even retail players in financial markets have to be experiencing whiplash with Fed Governors continually pronouncing their take on current inflation conditions.

Yesterday’s 1200-point drop in the DOW and 100 plus point drop in the S&P indexes should be a lesson for traders to take their finger off the trigger more often and not keep firing indiscriminately at such a moving target as U.S. stock and bond prices.

It’s difficult to steer in the right direction when eyes are focused on the rear view mirror and stagflation fears of another era.

Harlan Green © 2022

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

How Should We Remember 9/11?

ANSWERING KENNEDY’S CALL

BuildingCommunity

I wanted to remember 9/11 when I wrote my memoir on the Kennedy era that has just been released. It was also a time of busted communities, and a Vietnam War that split Americans. It was an Imperial America that wanted to make the world in its image, rather than create peaceful change that tolerated other peoples and cultures such as I worked for during the following years, after President Kennedy’s death.

I began writing this memoir about my work in public service in 2017, after wondering how it was possible that Americans had elected a president suffering a severe mental disorder. Did it mean our democracy was dying or already dead, and Americans now wanted a demagogue as president who believed that he was above all laws and the constitution?

It reminded me in many ways of the 1960s when there was just as much social unrest and different ideas of democracy. This was the era of McCarthyism and communist witch-hunting, right wing against left wing political views, the civil rights movement, and an unpopular war in Vietnam that was fracturing American communities.

We coped with the dysfunction and cynicism then by searching for communities that could mirror our values and ideals, and when we found them, to contribute to their growth.

I am writing about my years working to develop successful communities to show that it is possible to do it today in the face of so much social unrest that has created deep divisions and the possibility of future wars.

I believe that spirit of service is alive in younger generations that also want to make their country a better place. Many of them in the Millennial and Generation Z population groups are also searching for like-minded communities that serve a greater cause, that will bring people together in common purpose rather than separate them.

The Peace Corps was such a cause I believed in. I became a Peace Corps Volunteer to work in a program that improved the lives of Turkish farmworkers. A few years later I joined the Environmental Protection Agency at its inception because it was an organization dedicated to protecting the environment with the newly enacted Clean Water and Air Acts.

My membership in the United Farmworkers Union under César Chávez later in the mid-1970s was more happenstance. A cousin of mine in the construction trades roped me into helping him rebuild the UFW’s new headquarters, and it was extremely difficult to withstand the charisma of its founder and president, César Chávez. I was soon swept up in his vision of a union formed to improve the working conditions of Mexican farmworkers.

These were organizations dedicated to improving lives that taught me the fundamentals of healthy communities, fundamentals that enabled me to continue to improve the lives in my own community and led to the formation of a new California city.

There were many others doing what I did in that era. My history is one small part of the change that has been happening in American communities, towns, and cities whose members seek to improve their lives.

Former President Obama challenged Americans to inspire the youth to a life of service in 2017 after he left the presidency; and the youth he talked about are my target audience.  He said then:

We have some of the lowest voting rates of any democracy and low participation rates that translate into a further gap between who’s governing us and what we believe. The only folks who are going to be able to solve that problem are going to be young people, the next generation. And I have been encouraged everywhere I go in the United States, but also everywhere around the world to see how sharp and astute and tolerant and thoughtful and entrepreneurial our young people are. A lot more sophisticated than I was at their age. And so the question then becomes what are the ways in which we can create pathways for them to take leadership, for them to get involved?1

President Obama’s words came from his experience as a community organizer in Chicago. And studies show that Millennials and Generation Z youth now reaching adulthood want to make the world they have inherited a better place to live. Millennials’ preferences will be influential for no other reason than they are the largest generation ever, born from 1980 to 1996, outnumbering even their Baby Boomer parents.  They are also a much more diverse and tolerant population, which is why they are picking up where we left off in their preference for making worthwhile life choices. 

“Almost two-thirds (64 percent) of Millennials said they would rather make $40,000 a year at a job they love than $100,000 a year at a job they think is boring,” the Brookings Institution recently noted in a report by Morley Winograd and Michael Hais titled “How Millennials Could Upend Wall Street and Corporate America.”2

It cites a 2013 survey of over 1,200 U.S. adults that found Millennials to be the generation most focused on corporate social responsibility when making purchasing decisions.  Almost all Millennials responded with increased trust (91 percent) and loyalty (89 percent), as well as a stronger likelihood to buy from those companies that supported solutions to specific social issues (89 percent). A majority of Millennials reported buying a product that had a social benefit, and 84 percent of a generation that accounts for more than $1 trillion in U.S. consumer spending considered a company’s involvement in social causes in deciding what to buy or where to shop. In 2013, 89 percent of all American consumers said they would consider switching brands to one associated with a good cause if price and quality were equal.

One 30-year-old Millennial said in 2013, the 50th anniversary of President Kennedy’s death: “Though his [Kennedy’s] goals were typically big, what he sought from individuals was often rather small. Not everyone was expected to join the Peace Corps or become an astronaut or participate in the Freedom Rides. But citizens were asked to do their part—to think about how they could improve their community or make another person’s life easier—to look past their differences and focus on our common humanity. We badly need this message again. I believe it is one that resonates deeply with young Americans who are yearning for a time when we can search for new frontiers and once again be part of the same team.3

When Bad News is Good News

Financial FAQs

FREDserviceemployees

Doomsayers, such as historian Niall Ferguson, may be doing the Federal Reserve’s job by predicting a recession in the coming year. Their dire warnings are causing plunging stock prices for starters. And oil prices are plummeting as well, with WTI oil down to $83 per barrel at this writing.

Dr. Ferguson warned last Friday that the world is sleepwalking into an era of political and economic upheaval similar to the 1970s — only worse.

“The ingredients of the 1970s are already in place,” Ferguson, Milbank Family Senior Fellow at the Hoover Institution at Stanford University, told CNBC’s Steve Sedgwick.

“The monetary- and fiscal-policy mistakes of last year, which set this inflation off, are very alike to the ’60s,” he said, likening recent price hikes to the high inflation of the 1970s.

The U.S. economy is doing well, in spite of the doomsayers, as illustrated by the FRED graph above showing employment in the service-sector holding up that employs most American workers (gray bar is last recession).

The ISM’s service-sector index that measures business conditions at companies such as restaurants and hotels rose to 56.9 percent in August from 56.7 percent in the prior month, the Institute for Supply Management said Tuesday. It is the highest level since April.

“In August, the Services PMI^® registered 56.9 percent, 0.2 percentage point higher than July’s reading of 56.7 percent,” said Anthony Nieves, Chair of the Institute for Supply Management^® (ISM^®) Services Business Survey Committee. “The Business Activity Index registered 60.9 percent; an increase of 1 percentage point compared to the reading of 59.9 percent in July. The New Orders Index figure of 61.8 percent is 1.9 percentage points higher than the July reading of 59.9 percent.”

Yet inflation is already moderating with average gas prices below $4 per gallon and both the Consumer Price Index and Producer Price Indexes down from their highs.

Such fears generated by the doomsayers—with little to go on except past history rather than present conditions—are doing as much to bring down inflation as the Fed’s hawkish comments that they will continue to push up rates until inflation is tamed.

This is also indicated by the various surveys that measure consumers’ future inflation expectations, such as put out by the University of Michigan’s sentiment survey. Future expectations of CPI inflation have averaged 3 percent since 2012 when the survey was first conducted.

“The median expected year-ahead inflation rate was 4.8%, down from 5.2% last month and its lowest reading in 8 months,” said the UMich survey’s Director and Chief Economist Joanne Hsu. “Uncertainty over expectations rose considerably, particularly among lower-educated consumers. Long run expectations came in at 2.9%, remaining within the 2.9-3.1% range seen in the past year (actually since 2012 per its chart).

So, all the bad news about a possible recession may be good news for economic growth, and consumers, if it keeps the Fed from putting too much pedal to the interest rate metal, as the saying goes. The Fed may not have to keep boosting short-term rates if they see consumers and producers pulling back as demand cools.

The remarks from recognized pundits are enough to recall the draconian measures taken by former Fed Chairman Paul Volcker’s Fed that raised its overnight rate to 20 percent to combat the 1970’s era inflation, causing two subsequent recessions in the 1980s.

Fed Chair Powell’s Fed doesn’t have to fight inflation on his own. There’s help on the way from those pessimists who won’t see what is staring them in the face—an economy still recovering from the worst pandemic in 100 years.

Maybe it will keep the Fed from raising interest rates much further?

Harlan Green © 2022

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen

 

Why Slow U.S. Growth?

 Popular Economics Weekly

MarketWatch

Once again, all job categories were positive in the Labor Department’s August unemployment report. Professional/Business, Education & Health, Retail, and Leisure & Hospitality created 211,000 of the 315,000 nonfarm payroll jobs created.

Why does the Federal Reserve believe this is inflationary, when there are many other factors causing the current price rises, including record corporate profits?

Total nonfarm payroll employment increased by 315,000 in August, said the BLS. Nonfarm employment has risen by 5.8 million over the past 12 months, as the labor market continued to recover from the job losses of the pandemic-induced recession. This growth brings total nonfarm employment 240,000 higher than its pre-pandemic level in February 2020.

Once again, many pundits and some economists will say this unemployment rate that rise from last month’s 3.5 percent to 3.7 percent is still too inflationary and must rise further to tame this inflation surge and cool off economic growth, when it is risingcorporate profits causing most of the inflation.

Hiring more workers means creating more products, which should increase supplies thus driving down prices. But if corporations can increase their prices at an even faster rate, then inflation rises.

Their record profits, reaching  levels of the 1950s as a percentage of GDP, are a reflection of their ability to continue to raise prices, whereas wages and salaries increasing at 5.2 percent have fallen behind the inflation curve, lessening their buying power.

Economists are beginning to recognize that record profits may be more responsible for what I will call the current ‘profit-price’ spiral, rather than the ‘wage-price’ spiral of the 1970s that the Fed Governors seem to be focused on.

Quoting Reuters economist Jamie McGeever:“But looked at through the prism of profits, corporate America is also in rude health, especially big business. In the second quarter this year U.S. companies raked in profits that, depending on the cut, were the highest on record, or close to levels not seen in over half a century.”

“This is an inflationary threat too, but we hear far less from policymakers about it than the risk of wages fueling a price spiral that would only be crushed by interest rate increases like those administered by former Fed Chair Paul Volcker in the early 1980s.”

It may seem evident that consumer’s ability to pay the higher prices is part of the inflation problem, but consumers have little choice with the supply shortages of even basic necessities, and profits rising at an even faster clip.

I mentioned last week the role of corporations’ record, double-digit, profit growth since the end of the pandemic in causing record inflation. Data show that hourly compensation is now down -2.3percent since the end of the pandemic recession after inflation.

U.S. corporate profits as a share of GDP in the second quarter rose to 12.25 percent, says McGeever, around their highest levels since 1950. Profit margins for non-financial firms rose to 15.5 percent in the same period, closing in on last year's peak going all the way back to the 1960s.

Don’t we want businesses to keep hiring more workers to produce more goods and services? The Fed doesn’t, apparently, since it’s still focused on a completely different era when wages were rising as fast as profits. It is apparent that that is no longer the case.

Harlan Green © 2022

Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen