Stagflationary Winds
Last week, HAI noted this author’s suspicion that inflation will not be the dominant driver of Fed policy. Instead, signs of a weakening economy will likely provide the Fed an excuse to administer rate cuts it already seems anxious to deliver. This week, Jay Powell at the post-FOMC presser seemed to confirm that suspicion.
As we all know, inflation has been heating up so far in 2024. After falling toward the Fed’s 2% target in the back half of 2023, inflation data is now noncooperative. It’s still well above target, and is once again moving in the wrong direction. In the Financial Times this week, economist Mohamad El-Erian underscored the challenge now facing Powell by describing inflation as “likely to prove more persistent than Powell expects, given ongoing, multi-year structural transitions that are inherently inflationary.” After additional data this week confirmed the recent trend towards a noxious combination of both increasing prices and faltering economic momentum, El-Erian upped his warning by referencing the emergence of “stagflationary winds.”
Under immense inflationary pressure after a foolish attempt at a victory lap and consequent dovish policy pivot in December, Fed Chair Powell stepped up to the mic at Wednesday’s post-FOMC presser. The financial universe was braced for the possible return of Jay “Volker” Powell and his central banker tough guy routine. After looking goofy for hinting at rate cuts just before inflation resumed an upward course, would Powell return to 2022 Jackson Hole form? Perhaps now he’d be ready to beat inflation back to target by any means necessary—“unconditionally.”
Powell started strong by announcing in the first paragraph of his prepared remarks that, “inflation is still too high.” That was about it. Rather than hitting hard with exactly what he was going to do about it, he quickly turned wet noodle and followed with “further progress in bringing it down is not assured, and the path forward is uncertain.” He did restate the standard party line of “We are fully committed to returning inflation to our two percent goal,” but neglected to offer anything other than hope in the passage of time regarding how he might deliver that goal.
In fact, rather than reassert his hawkish Volker act, Powell was dovish again this week. The FOMC took a first step in dialing back its policy tightening when the Fed announced plans to significantly slow the speed of its balance sheet drawdown, or quantitative tightening (QT), program. In addition, Powell made it abundantly clear both in his statement and in the Q&A that, as far as he’s concerned—and despite evidence to the contrary, the year-to-date upswing in inflation data, and easier financial conditions now than at the start of the hiking cycle—Fed policy is in fact “restrictive.” As for the concern flagged by Mohamed El-Erian of an economy at risk of marching into stagflation, Powell dismissed it outright: “I don’t see the ‘stag’ or the ‘flation’.” In other words, he’s right back to dismissing reality and trying to inspire inflation-fighting confidence with little more than a Jedi-mind-trick wave of the hand. In short, this week’s presser wasn’t a high-water mark for Fed institutional credibility.
Injecting even more confusion, Powell noted that while he is “less confident than before” that inflation will ease in 2024, he nevertheless confirmed that it is unlikely that the Fed’s next move will be a hike. So the upshot is that, despite the total ineffectiveness of policy in 2024, the Fed’s game plan is to hold rates steady for now, directionally ease policy by slowing the pace of QT, and eventually lower rates.
Meanwhile in the real world, this week highlighted concern over stagflation. On Friday, April nonfarm payrolls disappointed with 175,000 new jobs reported last month, down from 315,000 in March and well below estimates for 243,000. The Conference Board’s consumer confidence survey sank to post-Covid lows, and the labor market component of the survey deteriorated notably. Fewer consumers reported that jobs are plentiful, and more say they’re hard to get. Consumers’ outlook for future labor market conditions also worsened significantly. A greater share expected fewer jobs in the next six months, and the ranks of those expecting more jobs over that timeframe dwindled. In fact, the latter number tumbled to the lowest level since 2011. Additionally, the latest JOLTS U.S. job openings data sang the same tune, dropping to a three-year low with a substantial miss vs. estimates.
Prefacing the weakening in NFP, the meltdown in confidence, and the drop in JOLTS data was April’s Chicago Purchasing Managers’ Index (PMI). The Chicago PMI is among the most highly respected in the macro data universe, and the latest reading collapsed to 37.9. To underscore the weakness indicated by this number, the synchronous decline to a reading under 40 in New Orders, Production, Backlogs, and Employment has only ever occurred in the recessions of 1969-70, 1973-75, 1981-82, 2001 and 2007-09.
In addition, ISM services and manufacturing both came in far weaker than expected. In fact, services fell more than all the 57 forecasts that form the Bloomberg consensus. The services and manufacturing composite fell from 51.4 to a contractionary 49.4, its lowest level since the end of 2022. Business activity witnessed the most significant drop, to its lowest point since May 2020. The employment component also exhibited significant weakness. Conversely, to add flation to the stag, the prices paid component spiked massively from 53.4 to 59.2. In fact, nine of ten key economic variables in ISM’s composite PMI either declined month-over-month or were in outright contraction. The lone exception was the surge in prices paid—which of course merely confirmed the overall message.
In short, while Jay Powell is saying he doesn’t see the stag or the flation, the real world is not impressed. HAI is feeling a distinct breeze from El-Erian’s stagflationary winds.
Following this week’s FOMC and Powell presser, former Fed board nominee and Trump economic advisor Judy Shelton asked what was, in HAI’s view, the question of the week: “If worried about inflation above target, why slow down tightening by reducing the runoff from the Fed’s portfolio?” Then, in quite a neat trick, Shelton proceeded to respond to her own question of the week with the answer of the week; “Seems like a concession to those who want lower rates without actually going for the rate cut.”
Shelton is on point, in HAI’s view. The Fed is trapped between needing high rates to fight an inflation problem and needing ultra-low rates to avoid a terminal debt spiral doom loop. Obviously, those needs are incompatible; as the IMF said last week, “something has got to give.” Right now, the Fed is rolling the dice on inflation. It’s trying to start easing in hopes the bond market will lower interest rates in response. That way the Fed won’t have to fully commit credibility suicide with an official fed funds rate cut just yet. If the stag portion of stagflation continues to worsen, weakening economic data will give the Fed all the cover it needs to follow through with an outright rate cut cycle regardless of inflation.
The country’s $35 trillion in debt converts to $35 trillion reasons the Fed needs to cut rates. With monetary policy so obviously and increasingly compromised, it’s no wonder gold, as financial insurance, has broken out. In HAI’s view, much higher prices await. In the meantime, mind those stagflationary winds.
Weekly performance: The S&P 500 was up 0.55%. Gold was off 1.64%, silver was down 2.06%, platinum was up 4.68%, and palladium dropped 1.03%. The HUI gold miners index was off 3.15%. The IFRA iShares US Infrastructure ETF was up 0.94%. Energy commodities were volatile and mixed on the week. WTI crude oil was down 6.85%, while natural gas surged 11.39%. The CRB Commodity Index was lower by 3.48%. Copper was off 0.37%. The Dow Jones US Specialty Real Estate Investment Trust Index was up 1.91%. The Vanguard Utilities ETF was up 3.59%. The dollar index was off 0.84% to close the week at 104.92. The yield on the 10-yr U.S. Treasury was down 15 bps to close at 4.52%.
Have a wonderful weekend!
Best Regards,
Morgan Lewis
Investment Strategist & Co-Portfolio Manager
MWM LLC
