Inflation & Interest Rates: share your data sources, models, and assumptions

[Paper Chaser]

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.

Were many people surprised by the .25 hike? Powell and other FOMC members had been publicly targeting 5-5.25 for awhile. That was the consensus from pretty much every source that I saw leading up to the FOMC meeting, and it was the unanimous decision by the voting members. I'd guess that they're now set up to pause for awhile and see how things respond as credit continues to tighten and the balance sheet continues to shrink.



The most recent ADP payroll report surprised with more than twice the expected increase in jobs:


Manufacturing jobs decreased, but service jobs (particularly in leisure/hospitality) saw huge gains:


Regional map of job gains/losses:


Manufacturing jobs tend to pay fairly well for their locations, while service jobs in hotel/leisure do not. Seems like we're trading high wage jobs in the South for lower wage jobs on the coasts.

Housing remains a mixed bag, with many markets seemingly 'bottoming' early this year now seeing some rebounding. The question is, how much of those gains are "seasonality", and will that dissipate as the buying season fades?

79 of 100 largest markets saw price increases in Feb:


That number increased to 93 of the top 100 markets seeing price increases in March:


With housing's outsized impact on inflation calculations, the recent trend in prices could be concerning for The Fed.

[dividendman]

I think we're going to get another rate increase of 0.25% soonish when we get more bullish numbers like those employment numbers.

Can employment go up and inflation go down?

[ChpBstrd]

In Powell's May 3 press conference, he essentially said the recent bank runs caught the Fed by surprise. He reiterated his belief that the US banking system was strong and resilient, and his statements about investigating the failures suggested that he sees them as one-off incidents.

But they're not one-off incidents. As noted in the academic paper I shared earlier, the entire US banking system has a mark-to-market value $2.2T below book thanks to 500bp of rate hikes over the past 14 months. Literally dozens of banks are at risk of bank runs, based on the authors' mathematical model. All banks have watched their securities lose several percent in value and are exposed to overbuilt commercial real estate.

The next shoe to drop will be the >$1T in CRE refinancing that must occur in 2023. Banks have already had their securities portfolios damaged. They are already worried about their regulatory capital levels and vulnerability to bank runs. So I think many owners of CRE, which is already facing high vacancies even in this environment of record-low unemployment, will be told to "find another bank and pay us back". But there won't be another bank, because most banks are in the same boat - desperately trying to raise capital by reducing new loans and taking payoffs from old loans. 

This scenario may seem a bit dramatic, considering that almost no banks have even cut their dividends yet (as they should be doing IMO). The trend doesn't need to be dramatic though, to force the sale of marginal properties that cannot be refinanced. And if the properties cannot be refinanced, who is going to obtain financing to buy them? A fire sale could be set off by a very small segment of the CRE market caught between banks that won't lend and a market that won't or can't buy. Then imagine the banks trying to offload their foreclosed properties.

The third shoe to drop will arrive when loan defaults increase as a recession starts. As today's 3.4% unemployment becomes tomorrow's 5-6% unemployment, a lot of car loans, HELOCs, personal loans, and business loans will turn bad.

Interest rate cuts should be helping banks by this time, and arguably they already are at the long-duration end of the spectrum. Ten-year treasury yields have fallen from 4.25% in October to 3.37% yesterday. But by this time any bank that has experienced a run, or braced for a run, will have a smaller portfolio of long-duration securities to benefit from the rate cuts. They will have been forced to sell them already, because securities are the most liquid portion of the portfolio aside from cash.

So the reason futures markets anticipate 75 basis points of rate cuts before the end of 2023 is because that's the only way to save the banks.

JPow might not yet realize what's happening, but the Fed Funds Rate futures market has been steadfast about late-2023 rate cuts since last year. The 5-year inflation breakeven and the 10y/3m yield curve have only become more steadfast in their implied predictions of a crisis. The 10y/3m yield curve has hit -189bp and is still falling, reaching levels of inversion that have never in history failed to predict a recession. By the New York Fed's own calculation, the odds of being in recession in May 2024 are 58% and rising. These markets have been wrong before, and academic research sometimes has limited applicability, but their narrative makes more sense than the soft landing scenario, and events have moved in favor of their interpretation.

I've sold a bear call spread on KRE.

[ChpBstrd]

CPI will be posted Wednesday. I predict:

     CPI: 4.75% annualized
     Core CPI: 5.75% annualized (flat)

Between March and April average daily closing price of the GSCI commodities index rose 3%, unemployment fell, hourly wages rose along the existing trendline, the economy created 253k jobs, and the labor participation rate was flat.

These mostly pro-inflationary factors may have been offset by a set of factors which are not yet reported, but which we have reason to believe could be disinflationary. For example, did banks pull back on lending / money supply in April? Did consumers continue to raise their savings rate per the trend since September? Did businesses reduce their inventories in response to tighter credit and higher interest rates?

Overall, when we look at a dashboard of economic indicators, the arrows have generally been up - at least through March. This is consistent with a Taylor Rule perspective that policy was still stimulative in Q1 because the FFR was below inflation (whether measured by CPI or PCE).

Now the FFR is 5.25% and it is entirely possible that April inflation was lower than the FFR. The April numbers could give us a first glimpse of a transitional economy that is moving from stimulative policy to restrictive policy. Until now, the economy has been able to create jobs despite higher rates, bank troubles, high inventories, and a rising personal savings rate because policy was stimulative. I'd say we're close to neutral now, with modestly positive real rates. Thus, the economy may behave differently going forward.

I think the Fed will pause in June when they observe inflation falling quickly below the FFR. Soon thereafter, they'll start to worry real interest rates may be increasing at an out-of-control pace which imperils the goal of a soft landing. Rapid disinflation plus worries about bank solvency are expected to force the FOMC to cut rates by 75bp before the end of this year.

To be clear, it would take a crisis to cause the Fed to pivot this quickly. The COVID-19 pandemic demonstrated they can move quickly in an emergency. Then the inflation episode which followed showed they prefer to give markets several months of notice before a major pivot, even if one of the core objectives of the Fed's dual mandate is at stake. They've been criticized for both the hasty move and the too-slow move, so maybe we should expect a pivot time somewhere between the zero month lag of 2020 and the 12-month lag of 2021-2022. After the December 2018 correction and collapse in PCE, the Fed took until August 2019 to cut rates for the first time.

Thus we should not expect a rate cut until 6-8 months after any major event that is less than a global cataclysm. That doesn't leave much time remaining in 2023 for 75bp of cuts, does it? I.e. if the crisis occurred tomorrow, the first rate cut after a 6 month lag would occur in November. That contradicts market expectations of a first rate cut in September. Each day that passes normally reduces the odds of a rate cut in 2023, so maybe intermediate-term rates will rise in the next few months.

[Psychstache]

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 :)

[ChpBstrd]

CPI will be posted Wednesday. I predict:

     CPI: 4.75% annualized
     Core CPI: 5.75% annualized (flat)

Actuals:

     CPI: 4.9%
     Core CPI: 5.5%

I'll call that a miss on both metrics. These numbers a little worse than I was hoping for. The futures market says there's an 80% chance of no movement after the June 14 meeting, but I have to wonder. I can just hear JPow saying "Inflation is still far above our 2% target..." like a robot and hiking us into oblivion.

[reeshau]

Fortunately, May and June are high comps--the peak of last year, on a month-to-month basis.  So, just stay steady on a monthly level should drop CPI 1.5%.

I'm sure lots of mass media will make note of the "trend."

I hope Powell will think about the fact he is addressing 3.5% inflation, which has indeed been stubborn, for nearly a year.

[Mr. Green]

Fortunately, May and June are high comps--the peak of last year, on a month-to-month basis.  So, just stay steady on a monthly level should drop CPI 1.5%.

I'm sure lots of mass media will make note of the "trend."

I hope Powell will think about the fact he is addressing 3.5% inflation, which has indeed been stubborn, for nearly a year.

I read the data differently. The last couple months are averaging a ~0.4% month over month increase. Thst would imply thst inflation may be sticky more or kess right where we are, in the 4-5% range. Unless we start seeing many of the month over month numbers droping to 0.1-0.2 were not going to see 2% inflation anytime soon.

[dividendman]

Fortunately, May and June are high comps--the peak of last year, on a month-to-month basis.  So, just stay steady on a monthly level should drop CPI 1.5%.

I'm sure lots of mass media will make note of the "trend."

I hope Powell will think about the fact he is addressing 3.5% inflation, which has indeed been stubborn, for nearly a year.

I read the data differently. The last couple months are averaging a ~0.4% month over month increase. Thst would imply thst inflation may be sticky more or kess right where we are, in the 4-5% range. Unless we start seeing many of the month over month numbers droping to 0.1-0.2 were not going to see 2% inflation anytime soon.

I think we're going to get another hike in the rates... I'm not doing anything about it though.

[FIPurpose]

Fortunately, May and June are high comps--the peak of last year, on a month-to-month basis.  So, just stay steady on a monthly level should drop CPI 1.5%.

I'm sure lots of mass media will make note of the "trend."

I hope Powell will think about the fact he is addressing 3.5% inflation, which has indeed been stubborn, for nearly a year.

I read the data differently. The last couple months are averaging a ~0.4% month over month increase. Thst would imply thst inflation may be sticky more or kess right where we are, in the 4-5% range. Unless we start seeing many of the month over month numbers droping to 0.1-0.2 were not going to see 2% inflation anytime soon.

The last 10 months have averaged closer to .3% per month. Even if you only look at the last 4 months it's averaging .35%. So you are overstating it a little.

We're currently in a 3.5-4% range.

[MustacheAndaHalf]

"The Consumer Price Index for All Urban Consumers (CPI-U) rose 0.4 percent in April on a seasonally adjusted basis, after increasing 0.1 percent in March, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 4.9 percent before seasonal adjustment."
https://www.bls.gov/news.release/cpi.nr0.htm

[ChpBstrd]

Fortunately, May and June are high comps--the peak of last year, on a month-to-month basis.  So, just stay steady on a monthly level should drop CPI 1.5%.

I'm sure lots of mass media will make note of the "trend."

I hope Powell will think about the fact he is addressing 3.5% inflation, which has indeed been stubborn, for nearly a year.

I read the data differently. The last couple months are averaging a ~0.4% month over month increase. Thst would imply thst inflation may be sticky more or kess right where we are, in the 4-5% range. Unless we start seeing many of the month over month numbers droping to 0.1-0.2 were not going to see 2% inflation anytime soon.

The last 10 months have averaged closer to .3% per month. Even if you only look at the last 4 months it's averaging .35%. So you are overstating it a little.

We're currently in a 3.5-4% range.

Here are the data direct from FRED, as monthly percent change:

Frequency: Monthly   
observation_date   CPIAUCSL_PCH
2022-04-01   0.4
2022-05-01   0.9
2022-06-01   1.2
2022-07-01   0.0
2022-08-01   0.2
2022-09-01   0.4
2022-10-01   0.5
2022-11-01   0.2
2022-12-01   0.1
2023-01-01   0.5
2023-02-01   0.4
2023-03-01   0.1
2023-04-01   0.4

Monthly Averages:
2-mo average:  0.25
4-mo average:  0.33
6-mo average:  0.27
8-mo average:  0.32
12-mo average: 0.40

Approximate Annual Inflation If the Following Monthly Percentages Continue for 12mos:*
0.1% --> 1.20%
0.2% --> 2.43%
0.3% --> 3.66%
0.4% --> 4.90%
0.5% --> 6.17%

* Formula used here is simply (1+monthlyrate)^12

Summary: It does look like we're stalled with inflation in the 3.3% - 4% range with no clear downward trend. I say no clear trend because the 2, 4, 6, and 8 month averages range up and down. This plus the highly positive jobs report and other economic indicators are why I worry about a June rate hike not being priced in by a market that is thinking in terms of what the FOMC "should" do in response to an emerging crisis in banking.

Seen through a certain lens, progress against inflation has been slow. Compared to the Fed's preferred inflation gauge, annualized PCE, real interest rates are still negative.

Meanwhile, falling mortgage rates are pushing up prices for the shelter component of CPI. The deeper the yield curve inversion goes, the less of an effect hikes to the FFR have on big purchasing decisions. Thus we have had a feedback loop between recession-predicting investors pushing down the yield curve, causing mortgage rates to stay lower, causing shelter inflation, causing rate hikes, causing recession predictions.

[Mr. Green]

If inflation remains sticky right around 4% I will not be shocked to see the Fed continue raising rates. Their rhetoric so far seems much more concerned about prolonged inflation than the banking system and I'd guess the exact 1970s scenario is in their minds if they begin reducing rates thinking they have inflation best only for it to coming roaring back, especially with data like the jobs report still indicating some strength in the economy.

[FIPurpose]

I think what some others have mentioned is that I don't know that you can enforce inflation with the FFR alone. As long as the administration remains resistant to breaking up monopolies, not enacting price gouging taxes, etc. Then the power dynamic hasn't changed and inflation will remain sticky until something else in the economy changes to remove company's ability to set prices so high.

It may be a 70's scenario, but I don't think the fed can solve it.

[reeshau]

...and pumping trillions in borrowed money into the economy, to fight the effects of the pandemic that has already been declared over, globally.

Right or wrong, it's inconsistent, to @FIPurpose 's point.  Let's drain the bathtub, while the spigots are still on full blast.

[ChpBstrd]

The Producer Price Index came out at a 0.2% monthly gain, good for a 2.3% annual increase.

Of course, this time last year we were in the midst of an energy and commodities bubble ignited by the start of the Ukraine war. These factors had pushed PPI up to 11% in March-June 2022. So it's not surprising to see PPI falling from those lofty heights now that the energy/commodities fears have subsided.

So why is CPI still 4.9% if producers are only facing 2.3% price increases? One reason is that wage increases are still in the 4.4% range. Another reason is that producers are including in their prices the costs of renewing hedges and contracts at higher prices amid higher volatility and inflation expectations. Imagine, for example, a trucking company that locked in this year's cost of fuel last year, or a steel producer that locked in their future prices of ore and rail transportation.

That is to say, the huge gap between CPI and PPI we saw in 2021-2022 has a feedback mechanism supporting higher prices in the future, even when the reasons for high prices have gone away. CPI and PPI are intertwined, and seem to revert back to each other on multi-year timeframes, after a bit of lag for reasons like those described above:



PPI is leading the way into disinflation, just as it did with the inflationary episode. If the current rate of annualized CPI decline continues, annualized CPI will hit 2% in about 8 months. As @Mr. Green noted above, that'll necessarily involve several months of 0.2% and 0.1% CPI increases. I think we should expect to see these starting soon.

[Paper Chaser]

Late, but figured I'd continue to post the CPI charts. Supercore (Services ex housing) was down from 1.4% to 1.26% MoM:



Used vehicles and fuel made up half of the MoM increase in CPI:

[ChpBstrd]

@Paper Chaser there's something odd about CPI being driven by cars and shelter. Both of these big ticket items are usually financed, which *should* make them sensitive to rising interest rates. Specifically, rising rates increase the price from the consumer's standpoint, and reduce their ability to pay.

To investigate, I looked into the following data points for cars:

1) CPI for used cars and trucks went up dramatically between mid-2020 and mid-2022, and has only partially moderated since then. The small price drops might be attributed to rising rates and spent stimulus checks, but it's smaller than one might expect from those reasons.


2) The average amount financed to buy a used car rose dramatically after 2020, going from stable pre-pandemic norms of $17k-$18k to $24,908 in 4Q2022.


3) The number of used cars purchased was fairly similar for the past 3 years.

4) The price of new cars has been rising as manufacturers cut production of cheaper models. From the article:

from December 2017 to December 2022, sales of new cars under $25,000 — affordable, by new-car standards — dropped 78% and went from almost 13% of total new-vehicle sales to just under 4%. Sales of new cars over $60,000, meanwhile, skyrocketed. Those vehicles, costing more than the annual income of the average American, went from 8% of the auto market to 25% of sales.

So as the narrative goes, a shortage of affordable new cars (like the discontinued Yaris, Fit, Sonic, Fiesta, Insight, etc.) is forcing former buyers of new subcompact cars into the used market to buy someone's 5 year old SUV for similar money.

I suspect something similar is happening with housing. The average new house is around 2,400 square feet, a 150% increase over 1980. These are the SUV's of houses, and smaller houses, in the 1,000-1,500sf range, are becoming harder to find in new developments. That forces home buyers into the used market for something that is (1) smaller, and (2) depreciated a bit.

It's fair to ask how such imbalances can exist in a capitalistic economy. If the demand is there, why isn't someone getting rich making small cars and small houses?

Maybe there are high enough fixed costs per unit (design, permitting, utility hookups, fees and taxes, etc) to make these items unprofitable. But have such costs really changed all that much in the past 20-30 years?

Or maybe there is sufficient used stock in the marketplace and buyers prefer to pay the same money for a used 1,500sf house instead of a new 1,200sf house? Similarly, they prefer to pay the same money for a 5-year old SUV as for a brand new Civic.

In either case, it means the stock of small used homes and small used cars shrinks every day. That's bad for frugal people, cyclists, pedestrians, and the environment.

 

[EscapeVelocity2020]

The odds of another 25bps hike June 14th are slowly increasing - https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html?redirect=/trading/interest-rates/countdown-to-fomc.html

Still below 50%, but I think the Fed is going to have to take a stance on if they are serious about lowering inflation to 2%.  Unemployment claims are still low and retail sales are healthy, it's hard to see any recession or credit crunch.  The speculation has been that the Fed will blink and allow their target inflation rate to drift up to 3 or 4%, but June should be telling.

[dividendman]

The odds of another 25bps hike June 14th are slowly increasing - https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html?redirect=/trading/interest-rates/countdown-to-fomc.html

Still below 50%, but I think the Fed is going to have to take a stance on if they are serious about lowering inflation to 2%.  Unemployment claims are still low and retail sales are healthy, it's hard to see any recession or credit crunch.  The speculation has been that the Fed will blink and allow their target inflation rate to drift up to 3 or 4%, but June should be telling.

If debt ceiling deal without crazy drama/default then rate hike.
If default/more than the usual craziness around the debt ceiling, then rate pause.

[ChpBstrd]

The odds of another 25bps hike June 14th are slowly increasing - https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html?redirect=/trading/interest-rates/countdown-to-fomc.html

Still below 50%, but I think the Fed is going to have to take a stance on if they are serious about lowering inflation to 2%.  Unemployment claims are still low and retail sales are healthy, it's hard to see any recession or credit crunch.  The speculation has been that the Fed will blink and allow their target inflation rate to drift up to 3 or 4%, but June should be telling.

Yes, the odds are rising, despite removal of the sentence about additional rate hikes being necessary from the FOMC press release. The FOMC seems to be split now, based on statements by various FOMC members (in order from most hawkish statement to most dovish):

Mester: said rates were still low enough that it wasn't probable that inflation would go down
Barkin: indicated comfort with more rate hikes if data support it
Williams: ambiguously described the lag between fed policy and effects
Logan: talked about a "slower pace of tightening"
Goolsbee: said his vote for the May rate hike was a tough call

Of the above, hawks Mester and Barkin are non-voting in 2023. I suspect Logan, Goolsbee, Cook, and Harker will vote against a rate hike in June. I think Kashkari, Waller, and Bowman will vote for a rate hike. That leaves 5 voting members in the middle of the hawks/doves scale to split the decision, including Powell, who sounded quite dovish earlier this month.

The vote may hinge on whether any additional bank runs occur, the May PCE reading to be released on 5/26, whether a debt ceiling deal is attained, or if market chaos breaks out.

We should keep in mind just how unusual it is to have a rate hike in every FOMC meeting for 15 months. During past rate hiking campaigns, the FOMC took breaks:

• In the 2015-2019 campaign, the Fed took no action between Jan-Nov 2016, Feb 2017, May 2017, July-November 2017, Feb 2018, May 2018, July-Sept 2018, and Oct-Dec 2018. Then the plateau held until July 2019.
• The 2004-2006 period of rate hikes looked very similar to today's straight line up, but even then the Fed took a break in June 2005.

It might seem prudent now that the FFR is roughly equal to CPI and PCE to shift toward an every-other-meeting rate hiking schedule to avoid overshooting and to allow for more data between decisions. The Taylor Rule would say the FFR needs to be substantially above inflation to push inflation down, but FOMC members concerned about the employment side of the mandate might point to data saying we're already there. By June 14, the FOMC will have April PCE (likely <5%) and May CPI (forecast: 4.34%), and both are likely to be well below the FFR.

Game Plan
It will be a bumpy June because we'll have anxieties up until the relief of the debt ceiling issue, but a positive outcome there only makes it more likely we'll get another rate hike on the 14th. With the VIX today falling to 16.5 again (!), it seems like a great time to for a long straddle or strangle for a quick flip, because VIX is likely to go over 23 at some point in the coming days and because there are two big events occuring in the next 27 days that will result in a big move one way or the other. Seen in this light, volatility is underpriced. I'm bidding on a $10 wide ATM August 18 strangle on SPY for $21.60/share.

[ChpBstrd]

I exited my strangle for a very small profit (i.e. a "dinner at a mid-tier restaurant" profit) when VIX hit 20 and it was not performing as expected in range-bound markets. In hindsight, it would have been more direct to have just bought VIX calls instead of also being tied to the performance of SPY.
-------------------
Germany has entered recession. According to the pundits and analysts cited, consumers ran out of money amid inflation that was 7.2% as of April.

I noted earlier how the EU strategy is to let inflation bail out their indebted Southern members for a while, and to not raise rates at the pace of the US. When the US rate-hikes itself into recession, the EU will inevitably follow. However, it will be healthier than it otherwise would be due to having lower rates and less vulnerability to inflated-away debts. The EU can't avoid recession, but they can at least freeload on the US's rate hikes without damaging themselves too badly.

The validity of this exploit+mitigate strategy is called into question by the German recession, and by the contrast with the US which has decent economic growth, lower unemployment, and much lower inflation despite an overnight lending rate ~125bp higher than the EU. However, the German recession makes it even less likely that the EU will aggressively hike rates to catch up with the US.

Stagflation and a weakening Euro would seem to be the prognosis for the EU, but I do not know enough about them to attempt predicting their behavior. In the US, people start howling for rate cuts at the first sign of economic weakness, but from a European historical, structural, and psychological perspective, inflation might be The One Problem to stay focused on. Stock ownership is much less common in the Eurozone than in the US, so an average consumer/voter might have more to gain from high rates than they have to lose.
----------------
April PCE is reported tomorrow!
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The US debt ceiling ransom negotiations are a binary event with a large downside and a probably-small upside. I still think Biden has little to lose by engineering a crisis that could be used to pin blame for the coming recession on Republicans. The debt ceiling is, after all, no more than a parliamentary procedure which in previous years was done away with by the Gephart Rule (basically saying, if you approve a budget or tax change, you approve the change in debt that comes with it.). That's a weak rationale for the president to violate the 14th amendment, so he might win in the right court.

This option is not talked about often, but Biden could also order the Treasury to run the printing presses to fund the government and honor existing debts until Congress allows additional borrowing. This would, of course, be highly inflationary but Biden could say his hands are tied by the debt ceiling on one hand and the 14th amendment on the other. Republican constituents, who are more sensitive to interest rates and stock prices, would be quickly calling their representatives to urge a resumption of borrowing. This scorched-earth approach would also potentially end debt ceiling brinkmanship for good - a key Biden goal. But it comes with a risk that the narrative could spin Democrats as the pro-inflationary party, so Biden or Harris - both poor messengers in general - would have to aggressively get out in front of such a narrative.

Overall, I'm avoiding exposure in this high-risk / low-return environment, where either crisis or resolution could be announced any day.
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ETA: Odds of a quarter-point rate hike on June 14 are now 53%!

[ChpBstrd]

Annualized April PCE: 4.4%. (+0.2% versus March)
Annualized April Core PCE: 4.7% (+0.1%)
April Personal Savings Rate: 4.1% (-0.4%)
Wages and disposable personal income were both up +0.4% for the month.

https://www.bea.gov/news/2023/personal-income-and-outlays-april-2023

This is a surprisingly bad report. Inflation rose and consumers were either unable to save as much or reverted back to last year’s behavior of pulling ahead purchases. This definitely increases the odds of a June rate hike. The odds were 50/50 yesterday and so far this morning the odds are 57% in favor of another hike.

[Paper Chaser]

Mentions of 'inflation' on earnings reports have gone down over the last year (although they're still sort of high), while mentions of 'job cuts' have increased (although they're still sort of low):


Historically, recessions typically begin right around the time that unemployment levels begin to rise. Here's where we currently stand:

[ChpBstrd]

@Paper Chaser I too have noticed the pattern of rising unemployment a few months to a year prior to recession, and I'm noticing how unemployment remains low now.

On the surface, robust employment suggests we are at least 6-12 months away from recession, but I've also noticed how initial claims tend to rise ahead of the unemployment rate. Wouldn't it be nice if we could watch initial claims to get an early warning of recession?


In a growing economy, people who file initial claims for unemployment insurance are quickly re-employed, and their spot on the chart is taken by the next person. Thus, initial claims keep happening but the overall unemployment rate stays low because the economy clears out each week's newly unemployed people and puts them to work.

In a shrinking economy, the people who filed claims last week are still unemployed the following week, so the following week's freshly unemployed people snowball on top of the previous week's unemployed people and as this process continues from week to week the unemployment rate starts to move.

Since February 2023, we've seen a divergence where initial claims have risen above 220k per week, but the unemployment rate has not yet gone up (as of April anyway):


This may be a signal that the unemployment rate is going to rise soon, unless the increased number of people filing initial claims can obtain employment as quickly as before. Can they do so in today's environment where there are supposedly more jobs than workers? We can address this question by overlaying the number of continuing claims for unemployment insurance over the initial claims and unemployment rate:


This last chart paints a picture of a slightly increasing snowball of people staying unemployed for multiple weeks since last fall. Continuing claims are currently 8x the number of initial claims, suggesting the economy is requiring 8 weeks on average to re-employ each person who files an initial claim. Back in September, this ratio was 6.75x. In theory, a rising continuing/initial claims ratio would predict rising unemployment in the future, because the longer it takes to re-employ people, the bigger the backlog of unemployed people becomes.

Unfortunately, there does not seem to be an easily-visible correlation between the continued/initial claims ratio and the unemployment rate. The ratio is noisy data, and if anything the ratio seems to rise after an increase in unemployment rather than serving as a predictor. So much for that plan. One gets a clearer signal just watching continuing claims or unemployment.


An even clearer signal comes from watching the annual percentage change in the unemployment rate. When this number flips positive, there are usually only a few months to go until the recession starts:

[MustacheAndaHalf]

Is there a good way out of 6% wage growth?
https://www.atlantafed.org/chcs/wage-growth-tracker

My thinking:
If it drops quickly, people tighten spending and we get a recession.
If it spikes too high or even stays at 6%, the Fed acts to stop wages fueling inflation.

[FIPurpose]

I don't think any of those charts are showing anything definitive. It looks like we've been hanging in the "maybe" period for the past 3-4 months. Nothing so far is a strong, definitive signal. We have a number of historical examples in even those charts of the economy tipping on the edge but then calming back down for several more years.

Personally I don't think the recession is happening. I think we may hang in this "close" territory for another 3-4 months and then cool down again.

[MustacheAndaHalf]

Personally I don't think the recession is happening. I think we may hang in this "close" territory for another 3-4 months and then cool down again.

Without citing any reasons, we should take your personal opinion when the Fed has stated the opposite view?

"US Federal Reserve economists still expected a "mild recession" at the most recent interest-rate meeting earlier this month, according to minutes of the meeting published Wednesday."
https://news.yahoo.com/fed-economists-still-expect-mild-192117143.html

[ChpBstrd]

Is there a good way out of 6% wage growth?
https://www.atlantafed.org/chcs/wage-growth-tracker

My thinking:
If it drops quickly, people tighten spending and we get a recession.
If it spikes too high or even stays at 6%, the Fed acts to stop wages fueling inflation.

I agree. The old pattern of the Fed hiking us into recession is the only outcome I can imagine. I would appreciate it if someone could paint me a different picture that is plausible. @FIPurpose do you want to give it a shot? Can you write a narrative of events in a possible future that doesn't involve a recession?

The PCE and wage numbers have led me to revise my prediction that the May rate hike was our last. I think we'll get another quarter-point in June and I'm 50/50 on July. The bank run crisis seems to have faded from the media narrative as PACW, WAL, CMA, KEY, and ZION have held the line through May. Thus, the FOMC simultaneously has less concern about setting off a banking crisis and more concern about inflation proving persistent. 

[FIPurpose]

My counter explanation would rest on the section of your graph that shows that is is possible for unemployment claims to rise without a rise in unemployment rate for long periods of time such as around 1996. And even then the most recent bump of unemployment claims over the past 2-3 months is maybe up about 10%?

I think it's tempting to look at the long-term chart and see that an unemployment rate of ~4% is historically low for our lifetimes', so our brains naturally anticipate that it must be ready to bounce back up. But what are some factors that might cause a lower unemployment rate compared to the past 40 years? The median age in 1995 was 34, now it is pushing close to 39. We no longer bring in immigrants at the same rate that we once did. I think our unemployment will remain low because we are in an extended period of retirement growth. A growing number of aging individuals who are being let-go, perhaps will take unemployment, but have no intention on returning to work.

In return, retirees will take on the brunt of a lot of this inflation. They will be competing for resources from the smaller pool of youth labor. Wages will continue to go up with inflation, but retiree income will lag. In effect, I think this will be a redistribution of wealth from older pockets to younger.

Recessions tend to come when we see people and businesses cutting back on potential projects. We've seen some of that especially in the tech industry, but we also haven't seen that at all in others such as service jobs. I don't think that's a recession as much as tech having to regroup. They were going off in directions that were a giant waste of money and resources because consumers fundamentally weren't interested.

P&E for the S&P is high but not outrageous sitting at around 24. We haven't seen corporate profits shrinking back yet, but rather they've held steady in a +/- 10% window for about 2 years now. Not a booming economy, but also not one that is deteriorating either.

The Fed in general hasn't been that good at guessing the future, so I don't know that I value their predictions beyond their value to forecast their own rate setting.

[Paper Chaser]

Since we're talking about employment, per the latest JOLTS data there are 1.8 job openings for every unemployed person at the moment:


You could draw a rough trendline in the downward direction in recent months, but it's still way higher than pre-pandemic.

[ChpBstrd]

My counter explanation would rest on the section of your graph that shows that is is possible for unemployment claims to rise without a rise in unemployment rate for long periods of time such as around 1996. And even then the most recent bump of unemployment claims over the past 2-3 months is maybe up about 10%?

I think it's tempting to look at the long-term chart and see that an unemployment rate of ~4% is historically low for our lifetimes', so our brains naturally anticipate that it must be ready to bounce back up. But what are some factors that might cause a lower unemployment rate compared to the past 40 years? The median age in 1995 was 34, now it is pushing close to 39. We no longer bring in immigrants at the same rate that we once did. I think our unemployment will remain low because we are in an extended period of retirement growth. A growing number of aging individuals who are being let-go, perhaps will take unemployment, but have no intention on returning to work.

In return, retirees will take on the brunt of a lot of this inflation. They will be competing for resources from the smaller pool of youth labor. Wages will continue to go up with inflation, but retiree income will lag. In effect, I think this will be a redistribution of wealth from older pockets to younger.

Recessions tend to come when we see people and businesses cutting back on potential projects. We've seen some of that especially in the tech industry, but we also haven't seen that at all in others such as service jobs. I don't think that's a recession as much as tech having to regroup. They were going off in directions that were a giant waste of money and resources because consumers fundamentally weren't interested.

P&E for the S&P is high but not outrageous sitting at around 24. We haven't seen corporate profits shrinking back yet, but rather they've held steady in a +/- 10% window for about 2 years now. Not a booming economy, but also not one that is deteriorating either.

The Fed in general hasn't been that good at guessing the future, so I don't know that I value their predictions beyond their value to forecast their own rate setting.

Thanks for taking on the challenge. I agree that employment trends are not always correlated with economic growth. Some of the fastest growth occurs right after a recession, when we're approaching peak unemployment and initial claims. An uptick in unemployment typically precedes a recession, but these upticks can also occur

In terms of cancelled projects, I think tech is lucky because they can quickly pull the plug on fads like the metaverse and redirect their resources elsewhere. If you have a real estate portfolio, a book of loans, or productive physical infrastructure, it's a lot harder to reverse a mistake once you realize it won't earn its cost of capital. The Fed's rate hikes have raised the cost of capital across all industries.

Consider a hypothetical multi-year business project or contract with a 5% ROI. Visualize an office skyscraper, retail development, apartment building, trucking fleet expansion, new business branch, new facility, services contract, etc. Such projects were being funded in 2019-2021, because the cost of capital was so low that leverage could be applied to boost ROE. Now, however, the cost of capital is above ROI and leverage is working the opposite way, so it makes sense to cancel the projects or at least try to minimize losses for a few years. There are entire companies in low-ROI industries (e.g. banking) that are suddenly bleeding value on all their projects, and these are bankruptcy candidates. The others will have to liquidate when they can no longer get loans to refinance their projects that the lenders can see yield less than the loans cost.

When enough such companies face that same conundrum, we get a recession, right?

[FIPurpose]

My counter explanation would rest on the section of your graph that shows that is is possible for unemployment claims to rise without a rise in unemployment rate for long periods of time such as around 1996. And even then the most recent bump of unemployment claims over the past 2-3 months is maybe up about 10%?

I think it's tempting to look at the long-term chart and see that an unemployment rate of ~4% is historically low for our lifetimes', so our brains naturally anticipate that it must be ready to bounce back up. But what are some factors that might cause a lower unemployment rate compared to the past 40 years? The median age in 1995 was 34, now it is pushing close to 39. We no longer bring in immigrants at the same rate that we once did. I think our unemployment will remain low because we are in an extended period of retirement growth. A growing number of aging individuals who are being let-go, perhaps will take unemployment, but have no intention on returning to work.

In return, retirees will take on the brunt of a lot of this inflation. They will be competing for resources from the smaller pool of youth labor. Wages will continue to go up with inflation, but retiree income will lag. In effect, I think this will be a redistribution of wealth from older pockets to younger.

Recessions tend to come when we see people and businesses cutting back on potential projects. We've seen some of that especially in the tech industry, but we also haven't seen that at all in others such as service jobs. I don't think that's a recession as much as tech having to regroup. They were going off in directions that were a giant waste of money and resources because consumers fundamentally weren't interested.

P&E for the S&P is high but not outrageous sitting at around 24. We haven't seen corporate profits shrinking back yet, but rather they've held steady in a +/- 10% window for about 2 years now. Not a booming economy, but also not one that is deteriorating either.

The Fed in general hasn't been that good at guessing the future, so I don't know that I value their predictions beyond their value to forecast their own rate setting.

Thanks for taking on the challenge. I agree that employment trends are not always correlated with economic growth. Some of the fastest growth occurs right after a recession, when we're approaching peak unemployment and initial claims. An uptick in unemployment typically precedes a recession, but these upticks can also occur

In terms of cancelled projects, I think tech is lucky because they can quickly pull the plug on fads like the metaverse and redirect their resources elsewhere. If you have a real estate portfolio, a book of loans, or productive physical infrastructure, it's a lot harder to reverse a mistake once you realize it won't earn its cost of capital. The Fed's rate hikes have raised the cost of capital across all industries.

Consider a hypothetical multi-year business project or contract with a 5% ROI. Visualize an office skyscraper, retail development, apartment building, trucking fleet expansion, new business branch, new facility, services contract, etc. Such projects were being funded in 2019-2021, because the cost of capital was so low that leverage could be applied to boost ROE. Now, however, the cost of capital is above ROI and leverage is working the opposite way, so it makes sense to cancel the projects or at least try to minimize losses for a few years. There are entire companies in low-ROI industries (e.g. banking) that are suddenly bleeding value on all their projects, and these are bankruptcy candidates. The others will have to liquidate when they can no longer get loans to refinance their projects that the lenders can see yield less than the loans cost.

When enough such companies face that same conundrum, we get a recession, right?

Well I think that's what's confusing about part of the Fed's strategy. You run up the fed rate to help drive inflation down, but then when bank assets drop in value, they risk a bank run and ultimately bankruptcy.

So the Fed injected more money than they were mandated to keep the lid on bank runs. Which in turn is a driver of inflation, injecting more money into the system.


I really think 2 things though will keep this from running into a recession.

1. A large chunk of inflation is being driven by corporate greed. That means if things do cool down, corporations have a lot of wiggle room in their budgets. So their ability to maintain production through a reduction in spending seems pretty good.
2. The deep yield inversion while typically a recession signal I think here is a sign that most bond holders are continuing to see the inflation and short-term rates as transitory.

By your response, it makes it sound like you believe the Fed will ultimately cause the recession itself. So we have bond markets and the Feds continuing a stand-off on who blinks first. I think the Fed will eventually have to be happy with 3-4% inflation, meeting bond holders and banks in the middle. Pushing rates to purposefully cause a recession is reckless. If we're going to get back down to 2%, I'd rather it be a smooth glide over a couple years rather than thinking the Interest Rate can hammer it down within a year.

[ChpBstrd]

I really think 2 things though will keep this from running into a recession.

1. A large chunk of inflation is being driven by corporate greed. That means if things do cool down, corporations have a lot of wiggle room in their budgets. So their ability to maintain production through a reduction in spending seems pretty good.

Corporate profit margins were relatively high for the last couple of years if that's what you mean. Still, I wonder how much of those high, but rapidly falling, margins are attributed to low interest rates. It's logical to say that some of the rate hikes could be absorbed by reductions in corporate margins, but this can only happen to a limit until the economy is shrinking. Reported margins have already fallen from over 12% in 2021 to 8.6% as of 4Q2022, which is close to the increase in the FFR up to that point. Past recessions tended to happen when profit margins fell below 4% so you may be onto something here. However, the post-COVID peak in profit margins may have also reflected the one-time effect of merchandise and labor shortages, which prompted companies to raise prices to exploit the situation. Seen in this light, the Q4 margins are just a reversion to norms, or the cost of labor catching up to inflation. The higher cost of debt is perhaps just now filtering down to companies whose pre-2022 debts are just now maturing.

2. The deep yield inversion while typically a recession signal I think here is a sign that most bond holders are continuing to see the inflation and short-term rates as transitory.

This is another way of saying something will happen that causes the Fed to cut rates soon. Traditionally, that event has been a recession. The bond market is also predicting a five-year breakeven inflation rate of 2.07% and falling. My interpretation is that people believe something dramatic is going to happen soon that will drive inflation to near zero in order to obtain that kind of 5 year average. It's hard to imagine a dramatic fall in inflation, from a CPI of 8.9% to 2% or lower, without a recession. The closest historical parallel might be the 2011-2015 period, when annualized CPI slowly fell from 3.8% in 9/2011 to -0.23 in 1/2015 without a recession. That's a minuscule drop compared to the ground we have to cover in this episode and the much shorter timeframe the Fed is willing to tolerate.

By your response, it makes it sound like you believe the Fed will ultimately cause the recession itself. So we have bond markets and the Feds continuing a stand-off on who blinks first. I think the Fed will eventually have to be happy with 3-4% inflation, meeting bond holders and banks in the middle. Pushing rates to purposefully cause a recession is reckless. If we're going to get back down to 2%, I'd rather it be a smooth glide over a couple years rather than thinking the Interest Rate can hammer it down within a year.

The 50+ year history of the Fed is they hike rates until a recession occurs. This has been the pattern in every recession since the Fed started targeting interest rates. It may be reckless, but the Fed has yet to invent another way to bring down inflation. The Fed attempted a slow rise in 2015-2019 which was not even in response to any significant inflation. The yield curve inverted and some overnight markets seized up. We'll never know if the slower pace would have caused a recession had COVID not happened, but I suspect it would have. Recent hikes have gone further and faster than the economy has ever recovered from without a recession.

[Mr. Green]

Looks like a US default is off the table. I'm sure there are a lot of folks happy that we've avoided adding that nasty variable to the current status of the inflation fight.

[Mr. Green]

339,000 jobs added in May, well beyond expectations, and the April jobs gain was revised upward. Unemployment rose to 3.7% from 3.5%. My guess is the strong jobs report seals the deal on another quarter point rate hike this month, especially now that we know the debt ceiling standoff is resolved.

[ChpBstrd]

339,000 jobs added in May, well beyond expectations, and the April jobs gain was revised upward. Unemployment rose to 3.7% from 3.5%. My guess is the strong jobs report seals the deal on another quarter point rate hike this month, especially now that we know the debt ceiling standoff is resolved.

I would think so too, but the CME Fedwatch tool has swung the other way, assigning a 61% chance of no rate hike in June. The catalyst behind this reversal was a series of comments by FOMC officials suggesting they will vote against a rate increase in the June 14 meeting:

Philip Jefferson, Patrick Harker, and Austan Goolsbee have made comments strongly suggesting they will be voting for a pause. These represent the dovish wing of the FOMC. Several other voting members were quoted with words to the effect of "we'll be data dependent based on the next few weeks' data." Since then, the jobs and PCE data have been uniformly inflationary.

So at least 3 out of 11 votes will definitely go for a pause. However, most of the hawks who have votes in 2023 have been wishy washy and not very passionate about June. Neel Kashkari for example called it a "close call" and Christopher Waller said on 5/24 "whether we should hike or skip at the June meeting will depend on how the data come in over the next three weeks". So other votes could join the doves in voting for a pause this month. Today starts the blackout time when FOMC members cannot speak about policy decisions.

In theory, anyone saying they were data dependent a couple weeks ago should be voting for a rate hike, but there's not a strong case to do this rate hike immediately. Why not wait until July? As non-voting member Bostic noted, "There's a long history of the Federal Reserve overshooting their policy and driving the economy into a more negative place. I would rather avoid that if we can."

It's a complete toss-up IMO.


 

[Paper Chaser]

In theory, anyone saying they were data dependent a couple weeks ago should be voting for a rate hike, but there's not a strong case to do this rate hike immediately. Why not wait until July? As non-voting member Bostic noted, "There's a long history of the Federal Reserve overshooting their policy and driving the economy into a more negative place. I would rather avoid that if we can."

It's a complete toss-up IMO.

I think it's funny that anybody at the Fed might be worried about the impact of another 0.25 hike being "excessive" after raising from 0 to 5.25 in 13 or 14 months. "The economy would've been fine if we had only avoided that last 0.25 rate increase! It's definitely not the other 96% of the rate hikes."

[EscapeVelocity2020]

Yeah, it's really hard to reconcile a Fed that says it is data dependent, has a mandate for full employment and a 2% inflation target, but also decides to 'wait and see' the effects of the rate hikes.  All the data points to needing more hikes. 

I'm guessing that the bank implosions have unnerved them around unintended consequences, but all indications are that those banks were not controlling risks - hardly the Fed's problem.  I believe that the Fed is going to find themselves more entrenched if they pause in June.  They will be between an even bigger a rock and a hard spot - elevated inflation and economic implosions.

June is going to be decisive as to if they really follow through on inflation targeted at 2% or if they eventually message that they are willing to allow their inflation target to increase.

[Paper Chaser]

I'd guess that the big thing that any doves might be considering (but not actually saying out loud) is the Treasury refilling the TGA now that the debt ceiling deal is done. My understanding is that it's expected to suck up around a Trillion dollars of liquidity before the end of the year which should act as QT, and likely leads to tighter credit from banks.

But I do think it's fair to wonder how much impact a 0.25 increase might actually have. I don't see this ending without a recession no matter what, so might as well rip the bandaid off and get it over with.

[EscapeVelocity2020]

Remember when good news like this strong labor reports used to be seen a bad news on the inflation front and send the market in to free-fall?  So now I guess good news is good news again?? 

[dividendman]

Remember when good news like this strong labor reports used to be seen a bad news on the inflation front and send the market in to free-fall?  So now I guess good news is good news again??

Good news is good news unless the good news will cause bad news, in which case good news is bad news. Bad news is bad news unless the bad news will cause good news, in which case bad news is good news.

However, expected bad news can be good news if it's less bad than the expected bad news, but if it's worse, it can be really bad news. Similarly, expected good news can be bad news if it's less good than the expected good news, but if it's better, it can be really good news.

The good news is that none of the news is bad news if you aren't reacting to any good or bad news. The bad news is that any news is bad news if you are reacting to any good or bad news.

The good news and the bad news is that the above is the best clarification we've got of the news.

[ChpBstrd]

Morgan Stanley expects a 16% profit drop:
https://finance.yahoo.com/news/morgan-stanley-sees-shock-16-014332650.html

I think they might be a bit late to this conclusion. S&P500 real earnings already dropped 18% in 2022:

S&P500 Real Earnings per https://www.multpl.com/s-p-500-earnings/table/by-month in April 2023 Dollars
Date                 Value
Dec 31, 2022    176.57
Nov 30, 2022    180.90
Oct 31, 2022    185.58
Sep 30, 2022    191.21
Aug 31, 2022    193.39
Jul 31, 2022    195.09
Jun 30, 2022    196.84
May 31, 2022    201.49
Apr 30, 2022    205.69
Mar 31, 2022    208.83
Feb 28, 2022    211.60
Jan 31, 2022    213.52
Dec 31, 2021    215.30

The odds of a June rate hike have flipped to 76% probability of NO rate hike. This plus the S&P500's 18% rally since October 2022 made me wonder if I'm behind the curve and missing an epic recovery that could endure through the coming recession as markets look forward to rate cuts. Bank failures and debt ceiling anxieties seem to have ended. I remind myself that the history of recessions includes some double-digit UP years in the year a recession starts, such as 1945's 30.3% return, 1980's 25.8% return, 1982's 14.8% return, or 2020's 16.3% return.

Recession
Year        Return      Following Year Return
1945   30.3%   -11.9%
1949   10.3%   21.8%
1953   -6.6%   45.0%
1957   -14.3%   38.1%
1960   -3.0%   23.1%
1970   0.1%   10.8%
1974   -29.7%   31.5%
1980   25.8%   -9.7%
1982   14.8%   17.3%
1990   -6.6%   26.3%
2001   -13.0%   -23.4%
2008   -38.5%   23.5%
2020   16.3%   26.9%
Source: https://www.forbes.com/sites/sergeiklebnikov/2022/06/02/heres-how-the-stock-market-performs-during-economic-recessions/?sh=3b69d5df6852

On the other hand, the last 8 months are not unusual in the history of bear market rallies. It is still the case that the economy has never recovered from 500bp of hikes to the Federal Funds Rate without a recession and it is still the case that the yield curve remains deeply inverted. The stock market going up does not mean a recession is not ahead and vice versa, as the Forbes data cited above demonstrate.
--------------------------------------------------
Duration of 10/2 Yield Curve Inversions:
Prior to 2020 recession: 3 days
Prior to 2008 recession: 1 month + 9 months (2 separate inversion episodes)
Prior to 2001 recession: 10 months
1998 false alarm / Asian financial crisis: 1 month
Prior to 1990 recession: 6 months + 2 months + 1 month (3 episodes)
Prior to 1981 recession: 13 months (recession started at month 10)
Prior to 1980 recession: 20 months (recession started at month 16)

Duration so far of 10/2 yield curve inversion: 11 months

So the current 10/2 yield curve inversion has already continued without a recession for longer than any inversion since 1980. In terms of depth, the current 10/2 yield curve inversion at -0.81% is the largest since the early 1980's, when Paul Volker was hiking the Federal Funds Rate to a peak of 19% and unemployment eventually hit 10.8%. 

Yet it's the 10y/3mo yield curve that really stands out. At current levels of -1.81% we are again in territory not seen since 1981. I used two similar definitions of the 3-month treasury rate to build the chart below, due to each metric having data for a different timeframe. The similarity of the lines where they overlap validates the use of secondary market yields for the older data. It shows the 10y/3mo spread reached a low of -1.654% prior to the start of the 1980 recession, and -2.64% prior to the start of the 1981 recession.

Source: https://fred.stlouisfed.org/series/DGS3MO

What to conclude from these data?

First, spreads are more extreme now than they were in December 1979 - the era of 12-14% inflation, a 13.75% FFR and 6% unemployment. It seems fair to ask if these wide spreads really make sense in today's much milder context of 5% inflation, a 5.25% FFR upper limit, and 3.7% unemployment? Are markets overreacting? Maybe what the spread is telling us more than anything is that the market today expects a quicker reversal of interest rates, or a reversal to a lower level of rates, than markets in 1979-1980 expected. I.e. inflation expectations have not set in to the bond markets like they had 44 years ago, as evidenced by today's low long-duration yields. In the 80's, interest rates quickly fell after the FFR exceeded inflation, but now in the 2020s we actually have more reasons to expect permanently higher inflation: a much higher national debt and much higher deficits in a lower tax regime (consumption being subsidized via debt), a slightly lower labor force participation rate (fewer workers per consumer now), and much older demographics (fewer workers per consumer in the long-term).

Second, the magnitude of the recession bond markets are predicting is based on (a) the expected decline in inflation caused by the recession and (b) the expected size of rate cuts that will occur. One might say the scale of recession being predicted by the markets is on par with the 1981 recession (3.6% increase in unemployment) and sufficient to drive the 5-year average inflation rate from today's 5% to 2.13%.  Markets seem to be expecting something a little less bad than the GFC (4.5% increase in unemployment). Compare the market's +2.13% predicted 5-year average inflation to the 2008-2012 simple average of inflation (+2.07%) or the 2009-2013 simple average rate of inflation (+1.6%). So it would be fair to say the market expects a 15-18 month recession in which we see unemployment increase +3.5% to +4%, two or three months of zero or negative annualized inflation, and a rapidly falling FFR.

Third, things could turn out all right if the Fed makes a quick pivot in the next few months before a recession sets in and loosens their definition of evidence that inflation is falling. There is a narrative that we can avoid recession if rates are cut quickly enough, if lending and real estate don't collapse, and if jobs hold up. Perhaps the futures markets which predict a 3.5-3.75% FFR by the end of 2024, are pricing in a gradual climb-down in rates as the expected inflation rate falls to about 3% this time next year. If the FFR follows inflation down, the reasoning goes, the cutting of rates and expectations for lower rates in the future will be stimulative. People and corporations will once again take on leverage to consume and grow businesses, excited by the possibilities of potentially refinancing at even lower rates in the future, and this will lift the economy away from negative growth. Of course, for this to happen the FOMC would have to cut rates before recessionary conditions set in, and well before meeting their 2% objective. This seems to be the narrative net buyers in the stock market believe. Of course, the FOMC cut rates prior to multiple other recessions and it was too little too late, so there's that. Still, I'm keeping/forcing my mind open to the possibility that stocks will defy history. In economics, longstanding patterns are broken all the time, which is what makes the science so dismal.
-------------------------------
I picked up five December 2025 420 strike SPY put options with high vega and practically no theta when VIX hit 14.75. I'll either flip these for a profit when volatility returns or use them to hedge a long stock position if stocks fall significantly. The problem with planning to buy on a dip is that volatility is so high during dips that it becomes expensive to hedge at that point, and so you're stuck between grabbing the falling knife un-hedged or paying a fortune for time value. The ideal play is to buy your hedge for cheap before stocks fall, and to buy the stocks you are hedging after they fall! I'm risking a relatively small amount of money to set myself up for a future opportunity that may or may not happen.

I would also not begrudge anyone for buying December 2025 call options right now, to cover the contingency that stocks go up through a recession or that a recession doesn't occur. They are, of course, a lot more expensive than the puts because stocks usually rise over 2.54 year periods. But, for example, someone buying the 425-strike call for $67.52 is only risking 15.8% of the $427.12 cost of the shares themselves, getting 60.5% of the change in SPY (delta), and at a cost of 3.31 cents per day per share (theta).

[ChpBstrd]

CPI is reported tomorrow (6/13) and PPI is reported Wednesday (6/14). The commodities trend has been down, and the initial claims / unemployment trend has been up. Both trends are disinflationary, so I will predict monthly increases on the lower end.

My predictions:

CPI: +0.2% monthly, +4.2% annual
Core CPI: +0.35% monthly, +5.2% annual
PPI: -0.3% monthly, +1.3% annual

Odds of NO rate hike in June are now 77% according to CME. I wonder what would happen to the nice little bull market we have going if the FOMC defied expectations? At the very least, I expect JPow to talk about how this is not necessarily the end of rate hikes.

Interesting side note: Labor force participation has been flat for 3 months, which is unusual and potentially inflationary when hundreds of thousands of jobs are being created. Now that we're back to the pre-COVID trend, is this the current ceiling in the number of people who are able to work? There was also a long plateau in labor force participation from October 2019 to February 2020.

[Bartlebooth]

My guidance to the fed: raise the rates until the help-wanted signs go away.  Almost every business is plastered with signs begging for employees.  It hasn't always been that way.

[Paper Chaser]

My guidance to the fed: raise the rates until the help-wanted signs go away.  Almost every business is plastered with signs begging for employees.  It hasn't always been that way.

I'm thinking that Baby Boomers leaving the workforce en masse as they reach retirement age is driving a good bit of that. Not only is it shrinking the workforce, but they're spending/consuming quite a bit (investments to the moon, tons of home equity, social security got a big bump, etc). Lots of the jobs that are available are in lower paying service industries, and worked by younger people, and there aren't enough of them to meet the demand. I don't see much changing that demography problem, so the only hope is for people, especially older people to reduce spending:

https://www.cnn.com/2023/06/12/economy/consumer-spending-baby-boomers-millennials/index.html

[FIPurpose]

May numbers out:

CPI: +0.1%, 4% annual
Core CPI: +0.4%, 5.3% annual

PPI comes out tomorrow.

Markets seem very skeptical towards a rate hike. Pricing in a 95% chance at no rate hike. The Fed rate is now basically matching Core CPI, and well above CPI. I say this is very good news overall.

[Mr. Green]

We're reaching the point where inflation won't fall much further with shelter still being 8%. Unless a healthy amount of inflation was corporate greed and we see disinflation deflation in some of these categories. Food is still running hot. So the two things that matter most, housing and food, people are still getting screwed on.

Edit: wrong term

[EscapeVelocity2020]

We're reaching the point where inflation won't fall much further with shelter still being 8%. Unless a healthy amount of inflation was corporate greed and we see disinflation in some of these categories. Food is still running hot. So the two things that matter most, housing and food, people are still getting screwed on.

More bad news for the rich / poor divide.  If you have equities, real assets, and bonds you are doing just fine keeping up with or ahead of inflation.  If you are renting, working a service job, and struggling to put healthy food on the table you are falling further behind...

[Paper Chaser]

Total CPI:


Goods are down over the last 12 months, but have been pretty flat for the last several readings. Energy seeing actual deflation. Services finally down a bit as well.



If we look at "supercore", medical care has been about the only thing declining for the last 6 or 7 months. Everything else is essentially flat.