Author Topic: Inflation & Interest Rates: share your data sources, models, and assumptions  (Read 133997 times)

gary3411

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February CPI came in at 6.0%. Looking at the month over month data, if the next few months continue to look like the last few, we should continue to see moderate decreases in overall CPI as the really hot months from the first half of 2022 fall off the calculation. MOM CPI was running over 1% through June 2022. On this trend alone, I think by the time we get to the July CPI release in August inflation would be in the 4s. Not awful, and would certainly support the notion of the Fed slowing down the rate hikes.

The food at home category continues to alarm me at 10.2%.

I don't see how that food at home category doesn't start to fall. Most commodity food staples are sitting near 52 week lows (Except beef).

FIPurpose

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So we've had about 6 months of running close to 4% inflation. The fed rate is currently sitting at 4.5%.

I don't see the argument for continuing to raise the rates. I think the feds will go back on their earlier statement and freeze the rate hikes with no change next week.

I get that they need people to believe the fed rates aren't transient, but continuing to raise the rates feels stupid.

Mr. Green

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The prospect of a soft landing certainly starts to feel like a real possibility. I think there will be a lot of tolerance with inflation at 3-4% to not overshoot. I'm going to say that if we have 5 more months like the last two, the July inflation report in August will come in at 4.3%. With healthy job gains still happening and the economy still kicking, as the fears of a recession start to fade and the realization that we may have topped out on interest rates, the outlook on housing is going to change and we may see a legitimate bull run start to take shape. However, norecession means interest rates may stay in the current neighborhood for years. Those expecting to refinance to lower rates fairly soon would be left out in the cold. I think that would also be good for housing prices long-term. Supply would probably continue to be limited supporting prices but I also think the psychology of higher rate setting in for longer will put downward pressure on prices so there will be some stagnation or even it continued slow fall in prices. After the incredible volatility of the last 2 to 3 years it would be refreshing to know that the price of a house over the next several years isn't really going to change much. Not so great for those people that have made a lifestyle out of home price appreciation but that's not a healthy business model anyway.

Finances_With_Purpose

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The top is in!

....oops, wrong thread.  Right idea, though.

(That is to say, who knows.  I do think we're at or near the end of the hikes, though.) 

Paper Chaser

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Core Services (Excluding Housing) is supposedly key for the Fed. It continues to rise MoM:


While it's slightly decreased YoY thanks entirely to Medical Care price reductions:


Used car prices have also accelerated rapidly after a brief lull:



It's not easy to see on this chart, but WARN notices typically lead unemployment claims by 4 weeks or , and they've shot up now:


Open Job Postings on indeed continue to decline:




Mr. Green

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@Paper Chaser it's interesting that the rise in YoY Core Services inflation is predominantly due to Transportation. Though the MoM chart shows it's following a similar pattern as overall CPI. Big MoM gains in the first half of 2022 followed by more tempered increases. I'm guessing the next several months will show falling YoY numbers as those early 2022 months age off.

ChpBstrd

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@Paper Chaser that's some interesting research! I'm interested to know if you or anyone has a link to somewhere that tracks the number of WARN notices over time, in an easy-to-read chart. This could be a good real-time indicator.

The prospect of a soft landing certainly starts to feel like a real possibility. I think there will be a lot of tolerance with inflation at 3-4% to not overshoot. I'm going to say that if we have 5 more months like the last two, the July inflation report in August will come in at 4.3%. With healthy job gains still happening and the economy still kicking, as the fears of a recession start to fade and the realization that we may have topped out on interest rates, the outlook on housing is going to change and we may see a legitimate bull run start to take shape.

Yea, as I think about it, most of the economic measurements suggest a soft landing. The things which don't suggest a soft landing are omens like the yield curve, the historical record of what the economy does when rates rise quickly, and other indirect things.

However, the reason we watch omens, look to history, and think about the future consequences of things like unaffordable mortgages and financial institutions stuck with depreciated bonds is because that kind of thinking is usually the only warning we get. Recessions often hit people by surprise, and by the time the direct measurement data go bad, it's too late to position oneself to avoid damage.

If the Fed is going to stop doing 0.25% rate hikes when YoY inflation hits 4%, and if 4% arrives in August, we should bear in mind that there are 4 more FOMC meetings until then. So the FFR could go up 25x4=100 basis points by then, to 5.75%. Is that your terminal rate forecast @Mr. Green ?

Something drastic has happened with the FFR futures market. Just one week ago, the highest odds were that the FFR would top out at 5.75% in September. Now the futures market suggests 4.75% will be the rate in September! Specifically, the market thinks rates go to 5% this month, and then get cut to 4.75% this summer, and then get cut another 25bp in November or December to end the year at 4.5%.

The CME FedWatch Tool has been stable for a long time, so this week's chaos is very interesting. Did the failure of a couple of specialty banks really change the trajectory of the Fed's rate hiking campaign by 125bp, just days after Powell said bigger rate hikes could be on the way? Would the FOMC ignore high inflation to keep a lid on the banking issues? Is the market panicking?

Maybe some big companies are using FFR futures to hedge the risk to their deposits over FDIC limits. By betting on a scenario where the Fed has to halt and reverse rate hikes within the next 3 months, these depositors are hedging the risk of events that could imperil their deposits. I.e. if more banks collapse, they might lose their deposits but on the other hand the fed will cut rates and they'll make millions on their futures contracts. Plus they'll have access to instant liquidity by trading out of the contracts. Investment banks might be buying up these contracts in anticipation of such demand, or to hedge the swaps they're selling to other companies and banks.

It's hard for me to tell if this is a market overreaction or a problem that is destined to spread, and if businesses and wealthy individuals will make withdraws or spread their non-insured deposits across other bank accounts or treasuries.

On the one hand, the banks which failed were one-of-a-kind in terms of having piles of uninsured assets or by having volatile crypto currency brokerages as clients. Also, the Fed just opened up a new emergency lending facility to prop up regional banks. Finally, the handful of largest banks with >$250B in assets should be safer because they are subject to stricter regulation.

On the other hand, we're back to pre-2008 levels of regulation for most banks, they're all holding the same treasuries which are down 7-8%, and there are tons of nervous people and companies with deposits in excess of the $250k insured amount. Thus there's no reason to think a banking crisis can't happen. If larger depositors move their funds to treasuries (note how treasury bond prices have gone up quickly) or even shuffle their funds across multiple accounts to maximize FDIC insurance, it will force the banks to sell some of their "held to maturity" bonds and recognize the losses, forcing more selling, and creating a chain reaction as their liquidity ratios drop with each tranch of asset re-characterization and loss recognition. Banks cannot quickly change their policies, and adherence to policies is what bank audits are about. Thus there may have been some reluctance to hedge as conditions changed, and there might still be hesitation since they know audits are coming. 

All this uncertainty makes it impossible to invest based on the last few days' events. Bank stocks, preferreds, and bonds are a bit like Schrodinger's Cat. They could be bargains or they could be worthless, and the only way to know is to wait for a future observation to occur.

It's the opportunity cost that keeps me away. If this year is turning out like 2000 or 2008, there will be better deals for those who wait as opposed to those who hop on the first little sale on risk assets.

Mr. Green

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@ChpBstrd a month ago I'd probably have said a higher terminal rate like 5.75% was likely. But now with the SVB/Signature/Credit Suisse news I'm more concerned about how psychology and fear are going to drive things over the next month or two. The Fed may have just found the breaking point, psychologically, if fear starts causing big reactions and we drive ourselves into a self-fulfilling prophecy.

I think there's a chance we're already at our terminal rate. I think that scenario looks like the Fed pausing in March, fear causes something else to happen and we react ourselves into a recessionary spiral over the next 6 months and then in August our current rate of 4.75% is above CPI.

Perhaps we're in that spot where if we don't psych ourselves out, a soft landing could be had, but it requires us to not psych ourselves out. We're not very good at that.
« Last Edit: March 15, 2023, 07:19:03 AM by Mr. Green »

FIPurpose

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The bid-ask spread on bonds has gotten pretty big. I've been following agency bond rates for a while now. 30 year bonds bids are currently at 5% whereas the ask is still at 4.5%. If this spirals into some really good long-term bond prices... I might have to consider some portfolio movements if 30-year bonds start hitting 5.5%.

BicycleB

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One model or set of assumptions that I have about interest rates and to some extent inflation comes from investment manager Howard Marks, courtesy of his public memos at Oaktree Management: sea change.

Roughly, he says we've undergone a sea change (major shift) out of the post-Great Financial Crisis era of very low interest rates to one with higher rates, resulting in different (and in the long run better) investment choices. He says that such shifts are rare - he's seen 3 in his 47+ year investing career. The eras part of the model includes:

inflationary, rising-rates era of 1970s;
declining rates era 1980s-2008;
super low rates (ZIRP) era 2009-2021;
today, back to normal non-ZIRP rates, with other normal characteristics reviving too.

Instead of a quantitative model for the details, he offers charts of qualitative characteristics to distinguish the two most recent eras. I'd post those directly here if I could, but they're in the memo linked below. The charts contain a dozen or more qualitative descriptions of various features in the current era, contrasted with the previous ZIRP era; the rest of the memo verbally extends and explains the summary chart while discussing the implications.

Overall, under ZIRP he felt that finding good investments at all was difficult, while the new era of higher rates gives advantages such as bonds being a legitimate option for normal investors.

https://www.oaktreecapital.com/insights/memo/sea-change

***

Here is his sea change model expressed as a summary chart; apologies for formatting by hand.
    
Characteristic                2009 to 2021                    Today

Fed behavior                 Highly stimulative              Tightening

Inflation                       Dormant                            40-year high

Economic outlook          Positive                             Recession likely

Likelihood of distress     Minimal                             Rising

Mood                           Optimistic                          Guarded

Buyers                         Eager                                Hesitant

Holders                        Complacent                       Uncertain

Key worry                    FOMO                                Investment losses

Risk aversion               Absent                               Rising

Credit window              Wide open                          Constricted

Financing                     Plentiful                             Scarce

Interest rates               Lowest ever                        More normal

Yield spreads                Modest                               Normal

Prospective returns       Lowest ever                        More than ample
« Last Edit: March 17, 2023, 07:44:19 PM by BicycleB »

EscapeVelocity2020

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Anyone else notice the recent Fed balance sheet trend - https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

MustacheAndaHalf

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I couldn't find an experienced investor covering this.  I figure some certifications (Chartered Alternative Investment Analyst, Financial Risk Manager) is better than none, so here's their take:

Quote
The Fed, however, launched a new bank funding facility, allowing banks to receive loans up to one-year using qualifying assets including any underwater, or below par, bonds as collateral.
...
“The rewidening of the Fed’s balance sheet and increase of USD liquidity are negative factors that are encouraging USD selling in the near-term,” MUFG said. The Fed’s balance sheet jumped by about $300B in the week to 15th March.
https://finance.yahoo.com/news/yen-eyes-more-gains-fed-175827024.html

ChpBstrd

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I couldn't find an experienced investor covering this.  I figure some certifications (Chartered Alternative Investment Analyst, Financial Risk Manager) is better than none, so here's their take:

Quote
The Fed, however, launched a new bank funding facility, allowing banks to receive loans up to one-year using qualifying assets including any underwater, or below par, bonds as collateral.
...
“The rewidening of the Fed’s balance sheet and increase of USD liquidity are negative factors that are encouraging USD selling in the near-term,” MUFG said. The Fed’s balance sheet jumped by about $300B in the week to 15th March.
https://finance.yahoo.com/news/yen-eyes-more-gains-fed-175827024.html

If the Fed’s balance sheet is expanding again, and the Fed has started exchanging bonds for cash, then we’re back to delivering economic stimulus, aren’t we?

The effects would be no different if the FOMC was buying bonds in the open marke, as in QE.

Of course, QT hasn’t been stopped, so the Fed is currently constricting the supply of cash and expanding the supply of treasury bonds in the open market via QT, while at the same time expanding the supply of cash and constricting the supply of treasury bonds via the bank loan program! The bank loan program is apparently much bigger than QT, judging by the Fed balance sheet chart above.

Who would have bet we’d be doing QT and QE simultaneously some day?! In all fairness, it makes sense. Banks are hurting for cash while the Main Street economy has had a surplus of dollars. The Fed’s “Quantitative Twist” is taking cash from one type of entity and giving it to another.

More importantly, we can locate ourselves on the path to recession. This is the point when banks become reluctant to make new loans, even if they can borrow from the Fed. Smart banks are aggressively taking the Fed loans, aware that the program can’t last forever, and aware of how many years of earnings it will take to fill the holes in their balance sheets.

blue_green_sparks

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It is sad we have to make workers/job market suffer and wreck the economy to slow inflation. You'd think there would be a supply side fix since in reality companies are making more money and selling less product. Seems like slicing an apple with a hammer to me.

Paper Chaser

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Smart banks are aggressively taking the Fed loans, aware that the program can’t last forever, and aware of how many years of earnings it will take to fill the holes in their balance sheets.


Mr. Green

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There's been speculation here that the stimulus given to banks after the Great Recession did not lead to runaway inflation because banks kept the money versus it finding it's way into consumers hands. Let's hope that is the case this time as well because that chart looks terrifying otherwise.

ChpBstrd

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I noted before that yield curve un-inversion typically happens a few months before the recession starts. For the 10/2, this false dawn occurred before the recessions of 1990 (11 mos), 2001 (3 mos), and 2008 (9 mos)(avg.=8mos).

Well, the banking chaos of the last week or two may have reversed the trend. The 10/2 yield curve remains inverted, but has recovered half the distance to zero. If the curve goes positive, expect a recession about 8 months thereafter.



There's been speculation here that the stimulus given to banks after the Great Recession did not lead to runaway inflation because banks kept the money versus it finding it's way into consumers hands. Let's hope that is the case this time as well because that chart looks terrifying otherwise.

In context, the $150B in discount window borrowing (so far) is relatively small compared to the $472B decrease in M2 since last March. However, the discount window program could potentially grow faster. We're at a point of uncertainty about whether we will have net QE or QT over the next few months.
https://fred.stlouisfed.org/series/M2SL

Overall, I agree banks are going to clamp down on new loans, because they're already too deep in risk and leverage as it is. Only a sudden cut in interest rates could restore the prices of banks' assets in the short term, but that such a cut could only happen in response to the sort of crisis that would hurt banks. Thus, the plan for banks is to just stay solvent long enough for rates to fall. That might be years.

SpaceCow

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Based on comments made during Powell's press conference today, he seems to believe that the development in the banking industry lowers the likelihood of a soft landing due to the resulting constraints on lending. Even so, he seems to be confident that it won't be the banking industry that pulls the US economy into recession.

When Powell was asked about potential rate cuts later this year, he stated "Rate cuts are not in my base case." While consistent with his previous comments, I thought this was worthy of note due to the marked disconnect between market expectations and the forward guidance that Powell has provided.
« Last Edit: March 22, 2023, 01:47:01 PM by SpaceCow »

Mr. Green

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@ChpBstrd I read an article earlier this morning where one market commentator believes the clamp down on bank borrowing may have the cumulative effect of a 1.5% FFR hike. It also mentioned a study claiming that 190 regional banks may be at risk of failure over the next 24 months. Definitely the possibility of a bumpy ride starting to take shape.
« Last Edit: March 22, 2023, 01:53:26 PM by Mr. Green »

EscapeVelocity2020

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Powell did seem to have a satisfactory explanation of the balance sheet increase.  Basically, it's a 'special borrowing window' given to the FDIC bridge bank to bolster the reserves.  It does not have the same intent or effect as QE, directly buying long term assets in order to guide rates lower and enhance liquidity...  QT is still ongoing, running the bonds off the balance sheet. 

A whole lot of discussion around just how much credit tightening will replace the Fed Funds Rate increases in the coming months.  There is a lot of literature but it is still too soon to know anything about how long and how much this tightening will replace FFR increases...  Peak rate is still averaging 5.1% with no cuts on the table for 2023, so basically no surprises to the upside for the market but no shocks to the downside either.  Like always, we will have to wait and see just how the inflation data tracks (especially the services sector, making up 54% of the economy).

gary3411

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On page 10, December, I was asked to guess the terminal rate. I said 4.75-5. I'm guna start an early victory lap :)

Paper Chaser

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On page 10, December, I was asked to guess the terminal rate. I said 4.75-5. I'm guna start an early victory lap :)

Early may be right. Markets are currently predicting one more 0.25 hike in May, and the FOMC projections for PCE and Core PCE inflation both went up since their last release in December.
 
According to the dot plot, only 1 member of the FOMC currently thinks the FFR will end the year under 5%, and if you compare to the plot from December they've gotten more pessimistic recently for both 2023 and future years ("Higher for Longer"):




Tightening in lending essentially acts like increased interest rates too which lessens the need for Fed hikes. Without recent bank failures, and the subsequent tightening the FFR would probably need to go even higher.
« Last Edit: March 23, 2023, 07:37:24 AM by Paper Chaser »

EscapeVelocity2020

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For the nerds in the group, this was an interesting explanation as to why Money Market funds went from 0.05% in Feb 2022 to 4.8% yield today and how the Fed contributed to the bank runs -
https://www.economist.com/finance-and-economics/2023/03/21/americas-banks-are-missing-hundreds-of-billions-of-dollars

I have been hearing rumblings that the Fed needs more regulation, so this was a timely primer on what went on with QE during Covid and then the time since QE ended
Quote
...But use of the facility has jumped in recent years, owing to vast quantitative easing (QE) during covid-19 and regulatory tweaks which left banks laden with cash. QE creates deposits: when the Fed buys a bond from an investment fund, a bank must intermediate the transaction. The fund’s bank account swells; so does the bank’s reserve account at the Fed. From the start of qe in 2020 to its end two years later, deposits in commercial banks rose by $4.5trn, roughly equal to the growth in the Fed’s own balance-sheet.

For a while banks could cope with the inflows because the Fed decided at the start of covid to ease a regulation known as the “supplementary leverage ratio” (SLR). This stopped the growth in commercial banks’ balance-sheets from forcing them to raise more capital, allowing them to safely use the inflow of deposits to increase holdings of Treasury bonds and cash. Banks duly took the opportunity, buying $1.5trn of Treasury and agency bonds. Then in March 2021 the Fed let the exemption from the SLR lapse. As a result, banks found themselves swimming in unwanted cash. They shrank by cutting their borrowing from money-market funds, which instead chose to park their cash at the Fed. By 2022 the funds had $1.7trn deposited overnight in the Fed’s reverse-repo facility, compared with a few billion a year earlier.

After the fall of SVB, America’s small and midsized banks fear deposit outflows. The problem is that monetary tightening has made them still more likely. Gara Afonso and colleagues at the Federal Reserve Bank of New York find that use of money-market funds rises along with rates, since returns adjust faster than those from bank deposits. Indeed, the Fed has raised the rate on overnight-reverse-repo transactions from 0.05% in February 2022 to 4.8%, making it much more alluring than the going bank-deposit rate of 0.4%. The amount money-market funds parked at the Fed through the reverse-repo facility—and thus outside the banking system—jumped by half a trillion dollars in the same period.

ChpBstrd

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Here are my notes from Powell's press conference:

-The forecast for real GDP growth is <2% for the next 3 years. That's similar to the 2009-2012 era, and is very close to a recession prediction.

-Dot-plot forecast FFR: 5.1% at end of this year, 4.3% at end of 2024, and 3.1% at the end of 2025.

-Guidance change: from "ongoing hikes" to "some policy firming may be appropriate". Then Powell told us to "focus on the words 'may' and 'some'". This is a notice that we're on pause after probably hitting a peak 5% FFR.

-Powell predicted that banks are going to tighten lending. At another point he said that if that prediction didn't occur, we might need more rate hikes. In another answer, he said bank credit tightening will "substitute for rate hikes". This is an admission that the bank squeeze will be doing the Fed's work for them, and a rationale for pausing rate hikes below the 12-month rate of inflation. He left open the possibility that banks won't tighten their lending, and I can see reasons why that might occur.

-Additional QT and bank reserve policy changes are not expected to be utilized.

-The difference between QT and the bank lending window: selling long-duration assets to change the term structure vs. making short-duration bank loans.

-----------------

Long-term treasury yields have an obviously big effect on asset prices. If we're now at the terminal FFR, any upward movement in long-duration yields would have to come from rising future inflation expectations. Long-duration yields usually fall during recessions as they did after the 1969, 1981, 1990, 2000, 2008, and 2020 recessions. Ten-year yields rose during the 1973 and 1980 recessions as inflation expectations were rising.



So if you're waiting on higher yields before locking in a purchase of long-duration treasuries, your expectation would have to be for inflation expectations to come unhinged. Now's as good a time to buy TLT or ZROZ as ever.

Yields for corporate bonds could also rise if the credit spread increases, which it often does during recessions. The BBB spread is only 1.83% right now, which is relatively weak compensation for risk. Expect this spread to hit at least 2.5% or 3% in a recession. Spreads will widen even more for junk bonds. That may seem like a small adjustment, but keep in mind the effects on long-duration bond prices!

Stocks, meanwhile, will stop falling due to interest rate pressure and will instead react to expectations around the recession, for better or worse. When volatility drops back to the VIX=18-19 range, it wouldn't be unreasonable to enter a long-term collar position or to buy some calls for upside protection. Yet the general expectation should be that stocks will drop during a recession. Historically, stocks have dropped despite aggressive rate cuts, and we might not even get the aggressive rate cuts this time around.


ChpBstrd

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@ChpBstrd I read an article earlier this morning where one market commentator believes the clamp down on bank borrowing may have the cumulative effect of a 1.5% FFR hike. It also mentioned a study claiming that 190 regional banks may be at risk of failure over the next 24 months. Definitely the possibility of a bumpy ride starting to take shape.
Powell said there's no way to tell, but I think the 1.5% FFR hike is a fair estimate. Perhaps this is a problem with the Taylor Rule; it does not account for the impact of bank constriction, and assumes a world where credit is always available, even as rates slide up and down the scale. In reality, when a nation goes from 0.25% to 5% in 13 months, it has an effect on shutting down loans from the banking sector, which compounds the effect of rate hikes, and this effect tends to occur within a span of a few months.

Here's another perspective on the problem/windfall:
"The Fed Has Overseen a Remarkable Transfer of Wealth From Bondholders to Taxpayers"

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...the market value of U.S. Treasury securities has gone from a high of 108% of the economy to its current value of 85%. This is one of the fastest declines in the U.S. debt burden and puts its value close to the prepandemic level.
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The windfall gain going to taxpayers has come largely at the expense of bondholders, including banks that have taken big losses on their bond investments.
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The dollar size of the economy... quickly recovered from the pandemic shutdown and was back on trend by mid-2021. This lowered the debt-to-GDP ratio by about nine percentage points. Next came the inflation surge, which further reduced the debt burden by 14 percentage points, bringing it to the current value of 85%. It did this through two channels. First, the high inflation pushed the dollar size of the economy about $1.89 trillion above the pre-pandemic trend.

Second, of course, is that the inflation surge caused the Fed to sharply raise interest rates, which lowered the market value of Treasuries by roughly $1.9 trillion. The fate of bondholders, therefore, changed. They suddenly were holding bonds that were worth far less than they had expected, both in inflation-adjusted terms and relative to other newer interest-bearing securities that paid more.

Bondholders, in short, paid for much of the reduction in the debt burden via the higher inflation.
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This remarkable transfer of wealth away from bondholders was not limited to the $24 trillion treasury market. Other fixed-income markets like the $12 trillion mortgage-backed securities market and the $10 trillion corporate bond market also saw big losses in market value. This is a key reason why banks, which hold such securities, are currently under stress. A recent study found that such assets in the U.S. banking system are overvalued by $2.2 trillion due to mark-to-market losses. This loss means many banks could not cover all the claims of their depositors should they flee en masse.

So if you didn't own bonds or banks for most of 2022, take a minute to feel the gratitude for inflation and higher interest rates. As a taxpayer, you've been relieved of trillions of dollars in real liabilities at the expense of the "banksters" who were so notorious after the GFC.

ChpBstrd

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I noted before that yield curve un-inversion typically happens a few months before the recession starts. For the 10/2, this false dawn occurred before the recessions of 1990 (11 mos), 2001 (3 mos), and 2008 (9 mos)(avg.=8mos).

Well, the banking chaos of the last week or two may have reversed the trend. The 10/2 yield curve remains inverted, but has recovered half the distance to zero. If the curve goes positive, expect a recession about 8 months thereafter.



Yield curve un-inversion (deversion?) continues to occur at a fast clip. So far in March 2023, the 10-2 spread has gone from -1.07% on March 7 to -0.38% on March 24. Two-year rates have fallen 1.24% in those two weeks, while 10-year rates only fell 0.59%. The interpretation is that bond markets think rate cuts are coming sooner than they previously thought.

The CME FedWatch tool supports this interpretation. Market participants are now pricing in a probability that we're at the peak FFR, and that the first quarter-point rate cut will occur in July, and be followed by 2 more rate cuts in 2023!

Think about how bad things would have to get to have 75 basis points of rate cuts in 2023, after multiple Fed officials effectively ruled out rate cuts this year.

As I noted earlier, yield curve un-inversion is typically a sign that the recession is only a few months away, with an average un-inversion - recession start time of 8 months, and with the shortest modern historical example being 3 months (2001).

If the yield curve reaches zero in mid-April, then July or August might be the soonest a recession could start. Thus I think the FFR futures market is a little off in its expectation of a July rate cut, but probably correct about 5% being the terminal rate. My prediction is that we plateau at 5% until at least October. 

FIPurpose

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If inflation plummets over the next few months and sends July's YoY to <4% then I could see the fed trying to aim for the soft landing might preemptively start cutting in July to prevent inflation over correction.

I think markets take what the Fed projects farther than 3 months out with a grain of salt. The fed is forever changing its stance based on its monthly crystal ball. We've been at ~3.5% inflation for the past 8 months. If that continues to slump and we hit 3% by July, suddenly the fed's insistence on keeping their 5% rate will look a bit foolish especially if it's further egging on a recession.

theninthwall

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So, assuming rates are at a peak or at least a plateau, what are the investments to look towards? I've been buying a lot of CDs lately, but I'm not sure if that is the right thing to do or not.

FIPurpose

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So, assuming rates are at a peak or at least a plateau, what are the investments to look towards? I've been buying a lot of CDs lately, but I'm not sure if that is the right thing to do or not.

I bought a slew of bonds last month in the 1-3 year range. Buy back into stocks if they are low and the recession really does happen.

ChpBstrd

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So, assuming rates are at a peak or at least a plateau, what are the investments to look towards? I've been buying a lot of CDs lately, but I'm not sure if that is the right thing to do or not.
IMO, we are transitioning from a period of rate hikes and inverted yield curves to recession, and this transition will take somewhere between 3 and 18 months. Then, within the following 3-18 months, investments become bargains.

My goal in this interim period is simply to not lose money. I want to ensure I'll have plenty of liquidity for bargain shopping later. I'm with you on short-duration highly safe instruments like CD's, treasuries, and money market funds.

Luckily, there are FDIC-insured 9-24 month CDs yielding 5.3% right now. You can lock up your money in these, and they might drop you off right in the ideal timeframe to go shopping for common stocks, preferreds, high yield, real estate, etc. These are yielding a lot more than comparably safe treasuries or MM accounts. If we are at an interest rate plateau, these are the highest safe-haven interest rates you'll see for a long time.

More aggressive investors with the same forecast might say buy TLT or ZROZ and ride it up as the predicted rate cuts happen, but I'm not so sure the rate cuts will happen on schedule. Multiple FOMC members have been clearly communicating "higher for longer" forward guidance. These same committee members have been 7-12 months behind current events for the past few years, so tack that timeframe onto your best guess recession start date and see how slowly rates could fall. Plus, rates in the longer durations have already fallen, so perhaps the "go long duration bonds" advice already panned out and the opportunity has passed. Will 10-year yields be lower in a year than today's 3.38%? I cannot form an opinion on that, so I'm not in long-duration treasuries now.

ChpBstrd

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February PCE:            +0.3%, trailing 12 months: +5%
February Core PCE:    +0.3%, trailing 12 months: +4.6%
February CPI:             +0.4%, trailing 12 months: +6%
February Core CPI:     +0.5%, trailing 12 months: +5.5%
February PPI:              -0.1%, trailing 12 months: +4.6%

Despite the recent bank runs, markets are starting to predict a 0.25% rate hike in May, which would bring the FFR upper bound to 5.25%.

A couple of current and former board members have made comments to prepare the groundwork for another rate hike. Richard Clarida and Susan Collins have made comments that make a May rate cut seem likely.

Long-duration treasury markets are already anticipating rapid disinflation. The 10-year yield has fallen 65 basis points in 32 days, to 3.43%.  The treasury/TIPS spread has a 5-year inflation breakeven of only 2.39%!

The song remains the same: Markets expect the Fed's rate hikes to cause a disinflationary financial stress event in short order. Futures markets still see a probability of rate CUTS as soon as this summer, and with the FFR down to 4.5% by December. Former Fed Vice Chairman Richard Clarida criticized this "disconnect" between market expectations and the Fed's actual thinking, but the futures markets are not blinking on this prediction.

Perhaps the relevant facts are these:
1) The bank run problem has been effectively ended via the Fed's lending-at-par program.
2) PCE is still running at 3x the Fed's target on a TTM basis, and 2x when looking at monthly data.
3) OPEC just cut production, which may bring oil back to $100/barrel soon.

Given these Facts, the FOMC's only defensible choice is to continue hiking. They probably shouldn't, but they will.

Real interest rates are not yet positive, and we are heading toward the Taylor Rule outcome Jim Bullard warned us about back in November 2022: a FFR between 5% and 7%. The Taylor Rule is looking pretty good as an indicator of interest rate trajectories!

The tricky part will be when recession-borne disinflation pulls PCE below 2%. Does the FOMC follow the Taylor Rule in the opposite direction at the same speed as they hiked rates? Or does the risk of a 1970's roller coaster in which inflation keeps coming back eliminate the chance of rapid rate cuts?


ChpBstrd

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I've been watching the National Financial Conditions Index with interest for the past couple of weeks. The NFCI represents the level of stress in the financial system and the difficulty companies face obtaining financing. When the NFCI exceeds zero, it is often because we are entering or in a recession. The NFCI can be thought of as representing the economy swinging toward or away from recession.

The NFCI had been trending back down (away from signalling recession) since last fall, but the regional bank crisis caused it to pop back up to within a hair of where it was in early October 2022. I think the NFCI will cross above the zero barrier sometime this year or early next year.


Paper Chaser

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What do we think about # of temporary employees as an economic indicator?


2020's was obviously different from most recessions with far less warning due to forced shutdowns, but in the other recessions temp employment peaked around 12 months prior to the official start of the recessions. The last peak was Mar 2022.

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Quote
Forecasts for the March CPI report show inflation is expected to post a 5.2% increase from a year ago, according to FactSet’s consensus forecasts. That would be well above the Federal Reserve’s target, but an improvement from the 6% increase shown in the February CPI report.

For the month, the CPI is forecast to rise 0.3%, while core CPI is expected to rise 0.4%.

https://www.morningstar.com/articles/1149028/markets-brief-march-cpi-report-forecasts-show-inflation-still-running-high

Early forecasting is coming out for March showing inflation continuing to be well under control another month. At this rate, YoY inflation will be under the Fed Rate by the time the May report comes out in June.

ChpBstrd

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What do we think about # of temporary employees as an economic indicator?


2020's was obviously different from most recessions with far less warning due to forced shutdowns, but in the other recessions temp employment peaked around 12 months prior to the official start of the recessions. The last peak was Mar 2022.

I like it a lot! If anyone is celebrating a 3.5% unemployment rate, what they're not thinking about is the hard limit on business growth. A successful company that wants to open another branch / store / facility physically can't, because there are no employees available to hire. Peak employment coincides with economic overheating, peak inflation, efficiency losses as people are forced to work beyond their limits and skillsets, and the beginning of a downturn.

Companies resort to temps in a desperate move to fill vacant seats or as a highly expensive recruiting strategy. They also resort to temps when they lack confidence in the sustainability of an upturn. These sound like the moves companies do at the cyclical peak.

Early forecasting is coming out for March showing inflation continuing to be well under control another month. At this rate, YoY inflation will be under the Fed Rate by the time the May report comes out in June.

Futures markets are assigning a 70% probability to a 25bp rate hike on May 3, and market participants currently think there is no probability at all that rates could go higher than that in 2023. So let's assume 5.25% as the FFR by June.

To test the mathematical plausibility of a FFR that is finally higher than YoY CPI in May, I did a little test.

First, I calculated the average drop in trailing-twelve-month CPI per month since the June 2022 peak. CPI has dropped 0.368% per month on average since June. TTM CPI for March was 5.986%. If we have another 0.368% drop in April and another 0.368% drop in May, then May CPI will be exactly 5.25% when announced in June. It is possible! I'd give it 50/50 odds, since that outcome is right on the trendline.

Of course, we could have a larger-than-typical CPI drop in April or May, such as the 0.69% drop between November and December. That would depend on a drop in the price of energy and other commodities, which is contraindicated by OPEC's recent announcement of production cuts but supported by falling US manufacturing numbers, a slightly rising personal savings rate, and the possibility that the banking crisis will prompt businesses to reduce inventories.

More importantly, the FFR > CPI milestone might be seen as the first time in this whole inflation saga when policy switched from stimulative to restrictive. It finally costs more to buy something with borrowed money and hoard it for a year than it costs to just buy it at a higher price next year*. Additionally, last year's supply chain and commodities issues have largely self-resolved, and the last of the COVID-era stimulus dollars have left the hands of the spending class and are now being used to buy long-duration US treasuries.

Perhaps when the history is written, the inflation episode of 2021-2023 will be attributed as follows:

9%-5% caused by post-helicopter money shortages of manufactured goods and rising commodity prices
5%-2% caused by interest rates being too low and QE enduring for too long
2%-0% baseline rate of inflation caused by intentional imbalance in supply/demand for dollars

*The obvious catch here is that yield curve inversion and still-modest credit spreads mean that for some investment grade companies, it still may be possible to borrow at sub-5% rates for a year or two at a time to finance the acquisition of assets that have increased in price at >5% over the past year. However, the inflation trend is working against this game plan. If TTM CPI keeps dropping at 0.368% per month, CPI will be 1.938% by March 2024. If this happens, anyone who borrowed money at 4-5% to hold excess inventory during that timeframe would lose 2-3% on their inflation hedge. The point is we're well beyond the time 6-12 months ago when it made sense to pull ahead purchases, and the aggregate demand hangover is coming on fast.
« Last Edit: April 10, 2023, 08:41:41 AM by ChpBstrd »

FIPurpose

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Looks like the inflation data was even better than expected for March.

March inflation YoY is 5% instead of the expected 5.2%. On a monthly basis, CPI rose 0.1% from February, as compared to a previous 0.4% increase.

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We've seen declines in prices of Fuel Oil, Gasoline, and Used Cars (although these have risen quickly again since Jan and are now the highest they've been since July 2022).



Inflation is higher now in Transportation, Food Away From Home, and Shelter than it was a year ago.
Prices on everything else continue to climb, although at a slower rate than last year. The only categories that are seeing inflation near the Fed's target of 2% are Apparel and Medical Care.

« Last Edit: April 12, 2023, 07:43:20 AM by Paper Chaser »

ChpBstrd

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@Paper Chaser those breakdowns really make me wonder: Do we have an inflation problem or a housing bubble plus a used car bubble problem? Without those two things inflation might be quite reasonable. And who is paying so much for used cars now that the shortage of new cars has been resolved?

Paper Chaser

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@Paper Chaser those breakdowns really make me wonder: Do we have an inflation problem or a housing bubble plus a used car bubble problem? Without those two things inflation might be quite reasonable. And who is paying so much for used cars now that the shortage of new cars has been resolved?

I'd say it's been an asset bubble across all classes. And low/zero interest rates in addition to unheard of amounts of new money exacerbated it for anything that could be financed. Housing costs have been the primary driver of CPI for quite awhile. Prices are softening in some places, and remain strong in others, so some improvement in OER might be expected in the later half of the year as last year's mortgage rate hike will start to show up in the YoY data. But I'm not expecting tons of decrease in housing costs nationwide in the next 12 mo. It will take time to fall noticeably on a nationwide average that CPI uses. And probably an increase in unemployment.

Manheim is a dealer auction. So the price reflected in that data is what dealers are paying for used cars at auction so they can resell them to consumers. They have limited inventory on their lots from the lack of new models that entered the economy over the last 2-3 years. It took a couple of years for supply/demand to stabilize after the GFC and Cash for Clunkers program. Similar deal here I'm guessing. Historically, the US auto market was around 17-18 million new vehicles per year prior to the pandemic. That dropped to under 15 million per year in 2020, 2021, and under 14 million in 2022. So that's somewhere around 7-10 million fewer vehicles in the market over the last 3 years in the US alone. That's going to take time to replenish. Or a massive decrease in demand caused by job loss/recession.

Semi related article about the current car buying environment: https://www.edmunds.com/car-news/where-did-all-the-cheap-cars-go.html
« Last Edit: April 12, 2023, 10:32:04 AM by Paper Chaser »

Paper Chaser

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Also worth keeping in mind that as far as recent disinflation in energy goes, that may be a temporary blip.
The US stopped tapping the Strategic Petroleum Reserve back in Dec 2022. Prices started to climb immediately with the average price per gallon climbing from $3.32/gal to $3.53/gal for March data ( an increase of 6%):

https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=emm_epm0_pte_nus_dpg&f=m

And AAA shows the current national average is up further to $3.62:

https://gasprices.aaa.com/

So with that added to the expected production cuts from OPEC, we're back to tapping the SPR again, currently sitting at the lowest level since 1983:

https://www.reuters.com/business/energy/oil-stocks-rise-unexpectedly-spr-release-weak-exports-2023-04-12/

Politicians can only buy so much more time before the SPR levels get dangerously low and they can't use them to dampen energy inflation. And then US consumers will be back to paying real fuel prices at the mercy of the global market.

MustacheAndaHalf

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The March 2023 data includes a year over year comparison of March 2022, which is the first year of inflation entirely after the Russian invasion of Ukraine.  The S&P 500 only rose 0.3% so far (2pm EDT), suggesting nothing surprising in the CPI data.

Paper Chaser shared graphs that track June 2022 inflation, which was the peak month last year (if I recall correctly).  For me, the next interesting CPI report will come out in mid July.

ChpBstrd

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Also worth keeping in mind that as far as recent disinflation in energy goes, that may be a temporary blip.
The US stopped tapping the Strategic Petroleum Reserve back in Dec 2022. Prices started to climb immediately with the average price per gallon climbing from $3.32/gal to $3.53/gal for March data ( an increase of 6%):
...
Politicians can only buy so much more time before the SPR levels get dangerously low and they can't use them to dampen energy inflation. And then US consumers will be back to paying real fuel prices at the mercy of the global market.
Good point @Paper Chaser . The traditional pathway to recession generally involves rate hikes plus an oil price spike preceding recession. Crude is already up 11% in the last 30d and futures markets anticipate another 25bp rate hike in 3 weeks.

The ingredients for recession seemed to be coming together in the first half of 2022, when oil and other commodities were spiking at highs not seen for 8-9 years. Yet interest rates weren't yet particularly high and the economy absorbed the price increases for that reason.

Then in the 2nd half of 2022 oil and other commodities collapsed as interest rates rose, and the economy survived high interest rates because of falling commodities prices.

Now it looks like we might get the combination of high energy prices plus high interest rates in the 2nd half of 2023.

ChpBstrd

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I agree with the market consensus this time and don't think there's much of a risk of the FFR exceeding 5.25%. When March PCE numbers are released next week, we're going to see a big drop. Here's why:

Reason #1 is that commodity prices generally fell in March. The GSCI Commodity Index has been my most reliable source for the past year as a predictor of whether monthly inflation will come in above or below expectations.

Reason #2 is that March CPI came in very cool, at +0.1%. It is possible for PCE and CPI to diverge, but usually they trend together. If anything, a long series of PCE vs. CPI makes it look like PCE is an amplification of whatever month-by-month trend CPI is displaying.

Reason #3 is that initial claims are finally rising. In March, this metric broke out of its previous 200k-220k/week range where it had been stuck for most of 2022 and entered a range of 230k-250k/week. Layoff anxiety and tighter lending could mean consumers make fewer purchases and the rising personal savings rate could have hit 5% in March.

March PCE is likely to be a negative number, maybe -0.25%. That may provide the FOMC enough cover to make a definitive "pause" statement in early May, which would be bullish for stocks. But then again, we're in danger anytime we calculate what the FOMC "should" do.  Politically there's no reason Powell should forecast what he expects out of future FOMC meetings and run the risk of having to backtrack.


ChpBstrd

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Welp, I was incorrect about March PCE coming in negative, but was at least correct that it would fall. I might have moderated my estimate had I thought more about yesterday's GDP report.

PCE was +0.1% in March.
Core PCE was +0.3% in March.

Per the GDP report, personal income rose faster than spending, driving the personal savings rate up to 4.8%. That's still a long way from the 7-9% common between 2018 and 2019, but it suggests consumers are pocketing their raises rather than spending them.

I considered that maybe consumers are discouraged from shopping because they can earn a respectable interest rate on CDs these days, but this viewpoint is contradicted by a decline in bank deposits since 2Q2022. I looked into this detail and found there was a net increase in "Large Time Deposits" but that was offset by a larger decrease in "other deposits". So bank accounts are getting smaller but they're not going into CDs. Can't apply mustachian logic to the masses!

Q1 GDP declined to 1.1%, but it wasn't consumer spending that pulled it down so far.

In terms of locating our place on the road to recession, the 10y/2y yield spread has risen since January, but has plateaued well below zero. As mentioned before, this curve has un-inverted several months prior to every recession of the past 3 decades - even 2020!

The 10y/3mo yield spread also tends to un-invert a few months prior to recessions, but it curiously remains in freefall to unprecedented lows. Investors now get paid 1.65% more to be invested in 3 month treasuries than 10 year treasuries, which is wild.

In summary, the lack of yield curve un-inversion suggests we have a long time to go until recession, at least according to bond market expectations, which have been wrong a couple of times in recent years.

Bond markets are predicting something will happen that is so bad the Fed will have to suddenly cut the federal funds rate in the 2nd half of 2023, and demand for longer-duration treasuries is extreme.

One such scenario might be a national debt default in June. Another is a rapid and dramatic domino effect of bank runs and failures after FRC goes down (still lots of accounts out there over the FDIC limit). The simplest scenario consistent with rate cuts later this year is the sudden onset of a severe recession, consistent with what historically happens when rates are suddenly raised hundreds of basis points.

It is easy to imagine GDP swinging to slightly negative in Q2 or Q3, but the more dramatic scenarios still seem unlikely. This Fed has been very slow to react to rising inflation and has yet to react to falling inflation, so absent a crisis it's possible we have two quarters of negative GDP before they even start talking about rate cuts. 

Overall I see no reason to change my strategy of hiding out in IG bonds, CDs, and money markets while the rate hike consequences continue to play out. I accept that I might be waiting another 8 months this way, but 5%+ yields make the waiting a lot easier.

The VIX is around 16.5 right now, and that contradicts the bond market. Thus, I picked up an on-sale put option on the S&P500 expiring in 602 days. My timing was probably bad because JPow is going to encourage markets by talking about a pause after next week's rate hike. Yet at this option's level of vega I think the puts are likely to appreciate even if we get a minor blip of volatility in the coming weeks, or prior to next week's rate hike. If I get far enough in the green, I might let it run further than just the next couple of weeks. FRC will probably be resolved by the FDIC and that should give things a bump.

ETA: Lower ocean bookings suggest businesses are feeling like they have a bit too much inventory. Inventories usually decline during a recession.
« Last Edit: April 28, 2023, 10:20:24 AM by ChpBstrd »

Tigerpine

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There may be a better place for this, but this link is to a segment from 60 Minutes in Australia.  I found it very interesting to hear about inflation from a non-American perspective.
https://www.youtube.com/watch?v=4cV5RjJaXAc

FIPurpose

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Kind of a surprise quarter point raise today. I personally can't explain it to myself other than the Feds don't like the market telling them what to do and are bullying their way to raise rates despite all signals that inflation is already cooling.

To me this looks like what could've been a soft landing into a full-submission on the market to basically grind into a recession. They don't like the markets signaling that these rates will be gone in 6 months, and will continue raising rates until the market has no choice but to raise the 10-year yields.

ChpBstrd

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There may be a better place for this, but this link is to a segment from 60 Minutes in Australia.  I found it very interesting to hear about inflation from a non-American perspective.
https://www.youtube.com/watch?v=4cV5RjJaXAc
IDK, the Aussie perspective sounds a lot like the American perspective. There are certain orthodoxies such as the "inflation or high interest rates, pick one" statement and the concept that government spending can be drastically cut without causing recession, even when govt is usually about 1/3rd of GDP. 

If I was an economist, I'd be promoting some unorthodox recommendations to escape these crusty paradigms. My favorite idea is to have a national sales tax tied to inflation. When inflation gets above target, the sales tax automatically moves up the next quarter. The tax creates deadweight losses and reduces consumption beyond what the price hikes themselves would do, immediately pushing inflation down. This approach would have key benefits over using interest rates in that it directly affects consumption and does not harm banks. Funds could be allocated for another counter-cyclical program which might be needed later, such as a stimulus fund or reverse tax to be tapped in the event of recession. The results of higher taxes and stimulus are well understood, so why not combine them in counter-cyclical ways? That seems like a much more promising world than lurching between inflation and credit crises.

The FFR was raised to 0.25% today. The following language appeared in the March statement but is absent from today's statement:
Quote
The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.

I take this as a sign most members of the committee consider us paused. JPow will have some positive things to say in his press conference which could stimulate the market in the short term. Oh, looks like markets already went up on the removal of that line. I expect we see a multi-month plateau from here.

theninthwall

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There may be a better place for this, but this link is to a segment from 60 Minutes in Australia.  I found it very interesting to hear about inflation from a non-American perspective.
https://www.youtube.com/watch?v=4cV5RjJaXAc
IDK, the Aussie perspective sounds a lot like the American perspective. There are certain orthodoxies such as the "inflation or high interest rates, pick one" statement and the concept that government spending can be drastically cut without causing recession, even when govt is usually about 1/3rd of GDP. 

One big difference with Australia is that most mortgages are on variable rates. The interest rate rises affect almost everybody with a mortgage, unlike the USA where it takes a while to impact a significant number of home owners.

ChpBstrd

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In case any of you aren't watching the "buy bank stocks on the dip" thread, I'll post the scariest thing I've read all week:
https://www.gsb.stanford.edu/faculty-research/working-papers/monetary-tightening-us-bank-fragility-2023-mark-market-losses

The paper sets up a logical model based on the percentage of uninsured deposits to describe when depositors will make a run on a bank and then applies that model to estimate the number of bank runs we might have. The results are startling.

Quote
The market value of U.S. banking system assets is $2.2 trillion lower than suggested by their book value. Interestingly, SVB does not stand out as much in the distribution of marked-to-market losses, with about 10% of banks experiencing worse marked-to-market losses on their portfolio.
Quote
...even if only 10% of uninsured depositors decided to withdraw their money, we would have 66 banks failing with about $210 billion of assets. If 30% of uninsured depositors ran instead, which is close to the share of withdrawals just preceding the shutdown of the SVB, we would have 106 banks failing accounting for $250 billion of assets.
Quote
We find that 10% (20%) default rate on CRE loans – a range close to what one saw in the Great Recession
on the lower end – would result in about $80 billion ($160 billion) of additional bank losses. While these
losses are an order of magnitude smaller than the decline in bank asset values associated with a recent rise
of interest rates, they can have important implications. An additional 285 (578) banks with aggregate assets
of $700 billion ($1.2 trillion) would have their marked-to-market value of assets insufficient to cover the
face value of all their non-equity liabilities. Even if half of uninsured depositors decide to withdraw, the
losses due to CRE distress would result in additional 21 (58) smaller regional banks at a potential risk of
impairment to insured depositors (over what we discussed in Section 4).

Second, a recent poll found that 55% of Americans were concerned about their bank assets. The results described above suggest their concerns are founded.

ChpBstrd

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There may be a better place for this, but this link is to a segment from 60 Minutes in Australia.  I found it very interesting to hear about inflation from a non-American perspective.
https://www.youtube.com/watch?v=4cV5RjJaXAc
IDK, the Aussie perspective sounds a lot like the American perspective. There are certain orthodoxies such as the "inflation or high interest rates, pick one" statement and the concept that government spending can be drastically cut without causing recession, even when govt is usually about 1/3rd of GDP. 

One big difference with Australia is that most mortgages are on variable rates. The interest rate rises affect almost everybody with a mortgage, unlike the USA where it takes a while to impact a significant number of home owners.
True. Australia and Europe lack the government-subsidized 3-decade fixed rate loans that insulate Americans from the direct impact of interest rate hikes. This is part of why they've been reluctant to raise rates to positive real levels.

Both Australia and the Eurozone are experiencing 7% inflation right now, which makes the US's sub-5% CPI look like a win. But the US had to raise rates to 5.25% and do quantitative tightening to get there. The Eurozone just raised their rates to 3.25% and Australia just raised theirs to 3.85%.

The Taylor Rule is looking better and better as US inflation plummets in response to positive real rates. So why aren't the Europeans and Aussies hiking rates at a 0.5% or 0.75% pace like the US did when we were equally far behind the curve? Should we expect their inflation fight to fail?

Luckily(?) for these economies, the US is boldly leading the way into a worldwide recession that will rescue them from the necessity of raising rates further. The slow pace of rate hikes is to protect the currencies while buying time. Their interest rates will peak far below the US's peak, they'll therefore do less economic damage, and they'll require less cutting in response to the recession.

The Euroaussie strategy will protect their real estate owners, but it relies on the assumption that a drop in US aggregate demand will knock out their inflation for them. Does that old assumption still apply in a world of service-driven economies and large financial markets in both the Euro and Australian areas? Could the US go into recession while the Euro and Aussie economies continue overheating? Probably the strategy is sound, but there's a small chance it's not.