Author Topic: Inflation & Interest Rates: share your data sources, models, and assumptions  (Read 134011 times)

wageslave23

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December CPI: -0.1% (+6.5% annual)(???)
December Core CPI: +0.3% (+5.7% annual)
Dec. Housing CPI: +0.8% (+7.5% annual)
Dec. Energy CPI: -4.5% (+7.3% annual)

https://www.bls.gov/news.release/cpi.nr0.htm

Basically, CPI fell due to falling energy prices, and despite higher shelter costs. Core CPI rose at a pace in December that would be 3.6% annualized.

Markets could see the falling energy prices in advance, and therefore predicted exactly the CPI outcome that occurred. What surprises me is the shelter component of CPI seems to be zooming continually up. This is despite the fact that mortgage rates fell slightly in December and we've had rent deflation since August.
https://ycharts.com/indicators/30_year_mortgage_rate
https://finance.yahoo.com/news/redfin-reports-rent-growth-slowed-130000426.html

There's probably a methodological / timing explanation, but how are these trends not yet being reflected in CPI for shelter?

@ChpBstrd upthread you wrote:

"If the analysts are right and CPI prints at their consensus index value of 296.7, we'll drop December 2021 from the annualized calculation and arrive at a new annualized inflation statistic of (296.7/281.933)-1)= 5.24%. This will look like a clear FOMC victory in the making."

CPI did come in at 296.79 but the LBS news release says that amounts to a 6.5% annual rate of inflation. I can't figure out where they're getting their inflation percentage from because it doesn't match the math of division.

Yea, this is confusing to me too. I had been using Fred's CPI for all items in US city average as a source, and dividing the Dec22 default index number by the Jan22 number, which looks to be incorrect.

I tried the math from Dec21 to Dec22 - which intuitively seems like 13 months but makes sense as 12 months if you consider both numbers to be the estimated price level at a fixed date each month - and it came out to ((298.112/280.126)-1)=6.42% That's still not 6.5%. Perhaps with these numbers three decimal places is still too much rounding?

Also, FRED reports an index value for Dec22 of 298.112 versus the 296.79 you saw. Where did you see that index value? FRED sets the index to 100 for 1982/1984 prices. Perhaps the BLS sets their index another way? This could be the key to the mystery.


The only way they're going to get back down to 2-3% inflation is to trim inflation in the services sector since that alone is ~4%. Or they'll need fairly significant deflation in the other areas to offset labor gains. I can't see prices going down as wages go up, but who knows.

These are great data. The rising price of services seems to be offsetting the improvements we should have seen from resolution of supply chain issues.

When I think about what could cause the price of services to rise, I think about not enough employees to meet demand. We're at full employment, so if demand>supply at full employment it might have something to do with the falling labor participation rate, which is a full 1% lower than it was pre-pandemic but trending up. That 1% adds up to millions of people out of the workforce. Labor could represent the new supply chain bottleneck, and the only things that could stop it are a recession or a boost in productivity.
https://fred.stlouisfed.org/series/CIVPART

Back in the days of direct stimulus, I would have cited too much money chasing too few services, but those days are long gone, and M2 has been in an unprecedented decline since March. Maybe there's still too much money, but this seems like a weaker and weaker explanation with each data print, and as inflation declines in other areas.
https://fred.stlouisfed.org/series/M2SL

I think the rising services cost is a lag due to the friction of an inefficient labor market.  Wages are sticky and a lot of people don't immediately demand their market value.  Lets say the market rate for a restaurant server last June up from $10/hr to $20/hr.  Only new hires are getting $20/hr.  All of the old employees won't see that increase until they switch to a better job in a few months or years.  So I think the last 6 months of wage gains are partially due to the rest of employees playing catchup.  Services cost is also sticky in that businesses especially services businesses are usually a little behind in updated their prices.  Some are on annual subscription services, others are small businesses that don't understand that they need to constantly raise their prices in order to keep up with rising costs, etc. 

I think the same can be said for the housing data, it lags real time.  They are not looking at the prices of recently sold homes in the last 30 days and the rental prices of the last 30 days.  They use past data to estimate current values. 

I think wages, services, and housing will all start to moderate over the next 6 months.

Viking Thor

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If you have Twitter and interested in inflation trendS Paul Krugman (Nobel winner economist) is good to follow.

He tweets about it fairly often. One thing he has pointed out is housing inflation as calculated in CPI is enormously lagged data.

Even the costs of a house itself are somehow based on rent costs (shelter cost), and rent leases are long term. So essentially the increase in shelter CPI you see in Dec report is driven by leases signed a long time ago. In essence he thinks shelter inflation is already low in reality but it will take a long time to show up in the CPI report.

I am explaining it poorly and clumsily but follow Krugman if you are interested and sometimes he brings it up.

Paper Chaser

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Details on how the "shelter" component of CPI is determined can be found here:

https://www.bls.gov/cpi/factsheets/owners-equivalent-rent-and-rent.htm

Here's a breakdown of the 'services' sector over time (including shelter):


And here is "Core CPI Excluding shelter":


Mr. Green

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@ChpBstrd I pulled the 296.797 value for December from the bottom of the BLS press release but I see now I missed the headline that that is the Not Seasonally Adjusted number.

SpaceCow

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Still, these voices in the wilderness deserve our attention, particularly now that we are at a turning point in rate hikes. The arguments they make are as follows:
  • Jobs are exceeding the workforce by millions, so millions of jobs could be lost due to higher rates without affecting unemployment. A typical recession's job losses are today's job slack.
  • Inflation is basically over, with 1.01% CPI inflation between June and November!
  • Europe and the UK were successful in their efforts to avoid gas outages this winter and to encourage conservation, so their businesses can continue production as planned. There's now a gas surplus.
  • China is reopening.

Each of these factors is a Very Big Deal, but coupled with the unemployment data and a number of other indicators it might seem to some observers that the soft landing is here already.

The futures markets and I agree the FOMC will raise the FFR by 0.25% on February 1. However I'm really starting to think some dovish comments will come out of the press conference and talks by Fed governors afterwards - perhaps even talk about doing 0.25% hikes on alternating months or doing the long-awaited "pause". If the odds of a 4.75% terminal rate go up, stock and bond markets could rally. Right now, futures markets are only calculating an 8.2% chance of a 4.75% terminal rate by June.

Let's pretend for one second that the terminal rate is 4.75% and not 5-5.25%. Given the long and variable lags for monetary policy might that 4.75% terminal rate might be enough to un-soft the landing? Isn't a 4.75% fed funds rate considered restrictive when inflation is 1%? Might we see deflation?

I would almost wonder if 6 months of inflation BELOW target is enough for a pause in February.



PDXTabs

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Still, these voices in the wilderness deserve our attention, particularly now that we are at a turning point in rate hikes. The arguments they make are as follows:
  • Jobs are exceeding the workforce by millions, so millions of jobs could be lost due to higher rates without affecting unemployment. A typical recession's job losses are today's job slack.
  • Inflation is basically over, with 1.01% CPI inflation between June and November!
  • Europe and the UK were successful in their efforts to avoid gas outages this winter and to encourage conservation, so their businesses can continue production as planned. There's now a gas surplus.
  • China is reopening.

Each of these factors is a Very Big Deal, but coupled with the unemployment data and a number of other indicators it might seem to some observers that the soft landing is here already.

The futures markets and I agree the FOMC will raise the FFR by 0.25% on February 1. However I'm really starting to think some dovish comments will come out of the press conference and talks by Fed governors afterwards - perhaps even talk about doing 0.25% hikes on alternating months or doing the long-awaited "pause". If the odds of a 4.75% terminal rate go up, stock and bond markets could rally. Right now, futures markets are only calculating an 8.2% chance of a 4.75% terminal rate by June.

Let's pretend for one second that the terminal rate is 4.75% and not 5-5.25%. Given the long and variable lags for monetary policy might that 4.75% terminal rate might be enough to un-soft the landing? Isn't a 4.75% fed funds rate considered restrictive when inflation is 1%? Might we see deflation?

I would almost wonder if 6 months of inflation BELOW target is enough for a pause in February.

The problem, as clearly illustrated by Paper Chaser, is "services less energy services". https://www.bls.gov/news.release/cpi.htm
JuneJulyAugustSeptemberOctoberNovemberDecember
0.70.40.60.80.50.40.5

1.007 * 1.004 * 1.006 * 1.008 * 1.005 * 1.004 * 1.005 = 1.0396508967757951
1.0396508967757951 * 1.0396508967757951 = 1.080873987166715

8.1% annualized services inflation

I don't know what the Fed will do with that. I don't even have an opinion as to what they should do with it. As always, check my math.

gary3411

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Still, these voices in the wilderness deserve our attention, particularly now that we are at a turning point in rate hikes. The arguments they make are as follows:
  • Jobs are exceeding the workforce by millions, so millions of jobs could be lost due to higher rates without affecting unemployment. A typical recession's job losses are today's job slack.
  • Inflation is basically over, with 1.01% CPI inflation between June and November!
  • Europe and the UK were successful in their efforts to avoid gas outages this winter and to encourage conservation, so their businesses can continue production as planned. There's now a gas surplus.
  • China is reopening.

Each of these factors is a Very Big Deal, but coupled with the unemployment data and a number of other indicators it might seem to some observers that the soft landing is here already.

The futures markets and I agree the FOMC will raise the FFR by 0.25% on February 1. However I'm really starting to think some dovish comments will come out of the press conference and talks by Fed governors afterwards - perhaps even talk about doing 0.25% hikes on alternating months or doing the long-awaited "pause". If the odds of a 4.75% terminal rate go up, stock and bond markets could rally. Right now, futures markets are only calculating an 8.2% chance of a 4.75% terminal rate by June.

Let's pretend for one second that the terminal rate is 4.75% and not 5-5.25%. Given the long and variable lags for monetary policy might that 4.75% terminal rate might be enough to un-soft the landing? Isn't a 4.75% fed funds rate considered restrictive when inflation is 1%? Might we see deflation?

I would almost wonder if 6 months of inflation BELOW target is enough for a pause in February.



You would think so. And I'm sure the fed even thinks so. But they seem to want to err on the side of doing too much. They are likely to raise again under the reasoning that even a small small chance of a rebound in inflation is unacceptable.

The fed will not always do exactly as they say, as we've seen in the past. However, they have been SOOO adamant about not being done raising rates, that if they truly stopped for good right now, it'd destroy their verbal reputation imo.

But Feb could certainly be the last one.

As an aside, I'm formulating a theory that cpi generally just follows the price of oil. Oil is so important, when it's price changes, the prices of everything else changes either shortly or mediumly afterwards.

ChpBstrd

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The Producer Price Index for December was -0.5%.  This compares with +0.2% in November, +0.4% in October, and +0.3% in September.



Annual PPI was +6.2% in 2022. However, the PPI trendline has been flattening since the commodities bubble popped in June, and IMO has generally followed the trend of the commodities indexes.
https://tradingeconomics.com/commodity/gsci
https://tradingeconomics.com/commodity/crb

As an aside, I'm formulating a theory that cpi generally just follows the price of oil. Oil is so important, when it's price changes, the prices of everything else changes either shortly or mediumly afterwards.

I prefer the GSCI or CRB indexes as a predictor of producer and consumer prices because they are diversified and "production-weighted". They also offer a smoother trendline than oil. There is a case to be made that oil is an input into many other commodities. Oil runs the equipment for mines and farms. Yet oil prices do not instantly transfer into wheat, pork, iron, lithium, etc. prices, so the indices should offer better predictive value of the prices actually being paid in a month.

But yes, I agree with the point that one can gain a lot of predictive power just looking at commodity prices. I had decent luck doing so in 2022.

Next: Personal Consumption Expenditures


PCE is reported on Jan 27, and I think each month's CPI and PPI give us clues about what to expect. December's PCE will set in stone the outcome of the Jan-Feb FOMC meeting. So far, the December CPI (-0.1%) and PPI (-0.5%), plus falling December retail sales (-1.1%)* suggest PCE fell in December.
*https://www.cnn.com/2023/01/18/economy/retail-sales-december?utm_source=business_ribbon

Strategy Notes


The FOMC would have a hard time justifying a 0.5% rate hike amid falling CPI, PPI, PCE, retail sales, sentiment, and manufacturing data. That's why the CME futures market currently implies 94% odds of a 0.25% rate hike. The market also still thinks 5% will be our terminal rate, and that rate cuts are coming later this year. This is despite multiple warnings by Fed officials (Bostic, Daly, George, Harker...) that the FFR plans to go above 5% and repeated statements by Powell that no rate cuts are expected in 2023.

Which side to take? I'm again torn between my assessment of what the FOMC "should" do and my historically-informed sense of what the FOMC "will" do. The FOMC probably "should" pause at 4.75% in March to acquire a couple more months of data, to see if the existing trend continues, and to let other central banks catch up, but history teaches us that the FOMC "will" keep increasing rates aggressively until a recession is, or at least appears, imminent. Also, neither the markets nor Fed officials accurately predicted what happened in 2022, so there are no experts to rely on.

My best guess is the FFR futures market is correct, and a pause will occur after a 0.25% rate hikes in February and March to a 5% terminal rate. But I also think FOMC officials are correct that they won't cut rates in 2023. +475 basis points in 12 months seals the deal for a recession - i.e. the economy has never recovered from that level of rate hikes without a recession - but that recession could start much later than many of us think. Besides, Fed policy lags economic reality by about 6-12 months, except in cases of catastrophes like 9/11 or the GFC. A mild recession starting in July might lead to rate cuts in early 2024, but the window for rate cuts in 2023 is closing rapidly.

This prediction is, of course, saying the Fed won't do exactly what a large chorus of Fed officials say they're going to do at their May 3rd meeting, which is a lot riskier than talking about years in the future. The Fed has historically been reliable in predictions of their own SHORT-TERM behavior, and has accurately telegraphed intent up to 5 months in advance (e.g. Powell started talking about rate hikes and ending QE in Oct/Nov 2021, 5 months ahead of the actual policy starting). Beyond that timeframe they're consistently wrong. Should I be listening to them more when they say they'll bury inflation in a deep grave in the coming months? Maybe. I have low confidence in my interest rate prediction.

These are all more reasons to quit trying to profit or avoid losses due to the market's under appreciation of rate hikes, and to instead focus on positioning ahead of a recession. Either the recession OR unexpected rate hikes will have similar effects anyway, and so far the data are converging on a scenario where we get both! This is an exciting and fortunate time for investors, who don't often get such clear recession signals as we're seeing today.

Mr Mark

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This is why I took a punt moving some REIT exposure/tax loss sale to some Vanguard long term treasuries a couple months ago...

MustacheAndaHalf

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Strategy Notes[/b]

The FOMC would have a hard time justifying a 0.5% rate hike amid falling CPI, PPI, PCE, retail sales, sentiment, and manufacturing data. That's why the CME futures market currently implies 94% odds of a 0.25% rate hike. The market also still thinks 5% will be our terminal rate, and that rate cuts are coming later this year. This is despite multiple warnings by Fed officials (Bostic, Daly, George, Harker...) that the FFR plans to go above 5% and repeated statements by Powell that no rate cuts are expected in 2023.

Which side to take? I'm again torn between my assessment of what the FOMC "should" do and my historically-informed sense of what the FOMC "will" do. The FOMC probably "should" pause at 4.75% in March to acquire a couple more months of data, to see if the existing trend continues, and to let other central banks catch up, but history teaches us that the FOMC "will" keep increasing rates aggressively until a recession is, or at least appears, imminent. Also, neither the markets nor Fed officials accurately predicted what happened in 2022, so there are no experts to rely on.
I'm mostly see things the same way as you mentioned.  But I would encourage you to look at 12 month CPI (+6.5%), 3 month CPI annualized (0.4 x 4 = +1.6%) and last month CPI annualized (-0.1 x 12 = -1.2%).  I would argue some of the rate hikes late in 2022 actually involved falling CPI and other factors you mention, and could contradict your assumption of what the Fed would do.
https://www.bls.gov/news.release/pdf/cpi.pdf

I also disagree with the claim of "no experts" because "the markets" didn't accurately predict 2022.  In 2021 Mohammed El-Erian (President of Queen's college at Oxford) called "transitory" the worst mistake he had seen from the Fed.  In Feb 2022, Harvard's Larry Summers (former Treasury Secretary) wanted the Fed to hold an emergency meeting to stop QE, which they didn't do.  And Jeremy Siegel warned of higher inflation.  Various experts understood things better than the Fed, and got it right.

Those same experts are less commited on what happens now, but each warns us against focus too much on a soft landing as the only possible outcome.  So they believe risk of recession is higher than the market expects.  Jeremy Siegel believes a soft landing is being ruined by overtightening from the Fed, so I'm not entirely sure if he expects a soft landing or not.  I think he's waiting to see the final Fed funds rate.

MustacheAndaHalf

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The following page contains Fed funds rate changes going back to 2000.  If others find more complete data, that would be welcome (maybe the Fed was more secretive back before 2000?).
https://en.wikipedia.org/wiki/History_of_Federal_Open_Market_Committee_actions#Historical_actions

You can look at starting year, Fed funds rate (FFR), and count how many months they held each rate.  What I gather is this:

2000 held 6.5% for 8 months
2002 held 1.75% for 10 months, then 1.25% for 8 months
2006 held 1.0% for 11 months
2020 held 0% for 23 months

One interpretation is that the Fed likes to hold lower rates longer.  Where 6.5% only lasted 2/3rd of a year, 0% lasted two years.  There's another problem: if you're only looking at inflation over 5%, suddenly you only have one data point.  Not that having only five was a great start, but add context and it turns to one.

Back in the 1980s, inflation was considered conquered after a single year (kinda like now...) and the Fed screwed up and loosened conditions.  Inflation came roaring back every year or so, until Paul Volker pushed the FFR so high that inflation was crushed.

I think Fed Chair Powell wants to be the good guy, the soft landing Fed Chair.  But if he puts all his chips on a soft landing, he can't invest in inflation being gone.  I'll be watching for him saying a soft landing seems less likely or unlikely... and that could signal recession chances are going up sharply.  Not guaranteed to even happen, but it's something worth watching for in 2023.

Paper Chaser

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I think more than wanting to be the good guy, credited for nailing a 'soft landing', Powell wants to avoid being the guy that eases too early and lets inflation flare up again (requiring more extensive rate hikes, longer economic pain, etc).

Here are some historic data sets that I think illustrate trends and timing of rates as they relate to inflation, recessions, and the labor market:




Trends that I see:
- Periods where the Fed has held rates steady after a trend of raising them typically precedes a recession
- rate cuts often start near the beginning of a recession
- both inflation and employment decline throughout the recession (unemployment rises)
- recession ends when employment begins to increase (unemployment declines)
« Last Edit: January 20, 2023, 08:09:30 AM by Paper Chaser »

Paper Chaser

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Also, not sure that the "time" scales of this chart have much validity or not, but the general trend seems to hold. I'd say that recent retail and manufacturing data suggests that we're somewhere in the "O" stage of "HOPE":

ChpBstrd

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I also disagree with the claim of "no experts" because "the markets" didn't accurately predict 2022.  In 2021 Mohammed El-Erian (President of Queen's college at Oxford) called "transitory" the worst mistake he had seen from the Fed.  In Feb 2022, Harvard's Larry Summers (former Treasury Secretary) wanted the Fed to hold an emergency meeting to stop QE, which they didn't do.  And Jeremy Siegel warned of higher inflation.  Various experts understood things better than the Fed, and got it right.

Professors at culturally-prestigious universities might fairly be asked "If you can predict the future accurately, why aren't you running a hedge fund? Why are you going the route of having your name attached to probably ghost-written books, and offering weekly commentary to financial media? How much does Yahoo Finance pay?"

We also might ask ourselves: How many similar experts are in the ecosystem of media influencers, and what the odds are of at least a handful of experts being right 2 or 3 or 4 times in a row? If there is an ecosystem of a couple hundred such individuals (academics, analysts, hedge fund managers, former govt officials) who are often quoted in financial media, then it is inevitable. We will always find someone with a long record of successful predictions, even if the population sample was monkeys throwing darts. We'd expect an even bigger selection of prophets with long records of successful predictions if we at least eliminated the most outlandish ones, like Dr. Doom or the Austrian school. The media tends to do that task for us.

FWIW, El-Erian said in 2013 that stocks were over-priced* in the midst of a historic bull run and Siegel predicted in 2000 that stocks would return 7% real(!) in the "intermediate run"** right before the down years of 2001, 2002, and 2003 and right before a lost decade. I actually had trouble finding these inaccurate predictions, because both media contributors create so much content the new tends to bury the old.
*https://investingcaffeine.com/tag/el-erian-predictions/
**https://en.wikipedia.org/wiki/Jeremy_Siegel#cite_note-5

While I think these sources are credible, well-informed, and intelligent, I also think people are fallible, and markets have a way of burning investors who follow prophets.

One interpretation is that the Fed likes to hold lower rates longer.  Where 6.5% only lasted 2/3rd of a year, 0% lasted two years.  There's another problem: if you're only looking at inflation over 5%, suddenly you only have one data point.  Not that having only five was a great start, but add context and it turns to one.

Back in the 1980s, inflation was considered conquered after a single year (kinda like now...) and the Fed screwed up and loosened conditions.  Inflation came roaring back every year or so, until Paul Volker pushed the FFR so high that inflation was crushed.

I think Fed Chair Powell wants to be the good guy, the soft landing Fed Chair.  But if he puts all his chips on a soft landing, he can't invest in inflation being gone.  I'll be watching for him saying a soft landing seems less likely or unlikely... and that could signal recession chances are going up sharply.  Not guaranteed to even happen, but it's something worth watching for in 2023.

I agree. If things are going well, why rock the boat?

Powell - who just oversaw the fastest series of rate hikes since Paul Volker - was actually known as an inflation dove. But it would be truly bizarre if he and the other doves weren't looking at the Arthur Burns experience from the 1970s. Dovish though he may be, Powell seems to accept his mandate to end the outbreak of inflation and was unafraid to hike rates at 0.75% per meeting. He may understand, as I've pointed our here before, that the inflation zombie keeps coming back unless you bury it in a very deep grave of positive real rates and accept the recessions that follow.

Today's talk of a 5% or 5.25% terminal rate sound a lot like...
... but then again the rate of inflation is dropping fast.

This will be a test of two competing interpretations of the Taylor Rule: Does the FFR have to exceed the highest peak in the inflation cycle, or does the FFR have to exceed the rate of inflation at any given time in the cycle.

I.e. if inflation is 5% this spring, will a 5.25% FFR bury inflation deep enough to keep it dead?

History says NO, but this time the Fed is using QT to pull back the money supply. I suspect QT has an effect bigger than Powell's estimate of it being equivalent to a 0.25% higher FFR (this is actually a very hawkish interpretation, IMO).

I get frustrated at every press conference when journalists fail to ask about specific parallels to the 1970s, because Powell's answers could reveal a lot about the FOMC's inflation fighting thought paradigm. I also wish journalists would ask more about QT - and whether it had a bigger impact on 2H2022 disinflation than rate hikes. These are the sorts of questions that will determine if we experience 0.25% hikes until recession or if we take a break for theoretical reasons. The Fed took breaks in 2000, 2006, and 2019 in response to worsening economic conditions, each time in reaction to positive real rates.

MustacheAndaHalf

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I also disagree with the claim of "no experts" because "the markets" didn't accurately predict 2022.  In 2021 Mohammed El-Erian (President of Queen's college at Oxford) called "transitory" the worst mistake he had seen from the Fed.  In Feb 2022, Harvard's Larry Summers (former Treasury Secretary) wanted the Fed to hold an emergency meeting to stop QE, which they didn't do.  And Jeremy Siegel warned of higher inflation.  Various experts understood things better than the Fed, and got it right.
FWIW, El-Erian said in 2013 that stocks were over-priced* in the midst of a historic bull run and Siegel predicted in 2000 that stocks would return 7% real(!) in the "intermediate run"** right before the down years of 2001, 2002, and 2003 and right before a lost decade. I actually had trouble finding these inaccurate predictions, because both media contributors create so much content the new tends to bury the old.
*https://investingcaffeine.com/tag/el-erian-predictions/
**https://en.wikipedia.org/wiki/Jeremy_Siegel#cite_note-5

While I think these sources are credible, well-informed, and intelligent, I also think people are fallible, and markets have a way of burning investors who follow prophets.
Nice research - I genuinely appreciate you finding El-Erians mistake from 2013.  He made an assumption which lead to a wrong recommendation to sell equities.  I hunted down the article because I wanted to track down his flawed assumption and understand it better.  Here is him making a flawed assumption and being wrong:


Quote
... central bank activism can be risky. For example, the more liquidity a central bank injects into the financial system, the more likely that nation's currency will drop in value against other currencies.
...
In terms of equity markets, El-Erian says investors are split into two camps. One camp believes that everything will go higher and central banks will succeed in their efforts. The other camp believes asset prices are going to come down to meet the fundamentals.

El-Erian puts himself in the second camp.
https://finance.yahoo.com/blogs/daily-ticker/pimco-el-erian-equity-prices-artificially-high-time-193327198.html

Although the financial crisis ended in 2009, the Fed decided in 2013 to increase its balance sheet from $3T to $4T, which is the context for El-Erian's comments.  I think my bias aligns with El-Erian's, which means not only was El-Erian wrong, but in the same circumstances I would expect to be wrong.

From 2013-2019, the Fed kept their balance sheet near $4 trillion, and then ran up another more than $4 trillion from 2020-2021.  I think these two injections of liquidity need to be distinguished.  In 2007-2009, the Fed injected liquidity into the largest banking institutions... which didn't lend it out, but kept the money.  It did not reach people's pocketbooks.  In 2020-2021, the U.S. government sent cash directly to Americans.  I think that explains why inflation didn't accelerate after 2007-2009 the way it has after 2020-2021.
https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

Looking back, it's still surprising that the Fed can inject money into markets and keep it there, fueling one of (or the?) longest bull markets in history.  I understand the simple dynamic at work, but I don't understand how that can be sustained so long... maybe because the borrowing is in U.S. Treasuries, which are the world's reserve currency?  With USD as the world's reserve currency, US Treasuries can be printed and fuel the U.S. stock market?  It seems very speculative to me, but certainly stock market gains went on for a very long time.

Jeremy Siegel wrote "Stocks for the Long Run" back in 1994, and since it has been so long since I read it, I'll quote from Wikipedia's summary:
Quote
Siegel argues that stocks have returned an average of 6.5 percent to 7 percent per year after inflation over the last 200 years
https://en.wikipedia.org/wiki/Stocks_for_the_Long_Run

If he believed that in his book in 1994, and in every edition printed since then, I think it's reasonable for him to believe it in 2000.  I didn't look at his year 2000 comments, but if he simply didn't predict the dot-com crash, and stuck to his "Long Run" belief that stocks rise "7% per year after inflation for the last 200 years", he is essentially being on brand in saying that.

MustacheAndaHalf

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I also disagree with the claim of "no experts" because "the markets" didn't accurately predict 2022.  In 2021 Mohammed El-Erian (President of Queen's college at Oxford) called "transitory" the worst mistake he had seen from the Fed.  In Feb 2022, Harvard's Larry Summers (former Treasury Secretary) wanted the Fed to hold an emergency meeting to stop QE, which they didn't do.  And Jeremy Siegel warned of higher inflation.  Various experts understood things better than the Fed, and got it right.
Professors at culturally-prestigious universities might fairly be asked "If you can predict the future accurately, why aren't you running a hedge fund? Why are you going the route of having your name attached to probably ghost-written books, and offering weekly commentary to financial media? How much does Yahoo Finance pay?"

We also might ask ourselves: How many similar experts are in the ecosystem of media influencers, and what the odds are of at least a handful of experts being right 2 or 3 or 4 times in a row? If there is an ecosystem of a couple hundred such individuals (academics, analysts, hedge fund managers, former govt officials) who are often quoted in financial media, then it is inevitable. We will always find someone with a long record of successful predictions, even if the population sample was monkeys throwing darts. We'd expect an even bigger selection of prophets with long records of successful predictions if we at least eliminated the most outlandish ones, like Dr. Doom or the Austrian school. The media tends to do that task for us.
I think your second point is important, but I dispute your first claim.  Most people in "Investor Alley" invest passively using index funds.  The giant among investment books for that theory is "A Random Walk Down Wall Street".  It was written by Burton Malkiel, who is a "professor of economics at Princeton University".  He might feel hedge funds overcharge and underdeliver, and like teaching.  Multiple websites put his NW at around $1M to $2M, suggesting the websites are wrong or he does not emphasize his NW.  A top investment book writer can decide not to cash in, which is an anecdotal example that professors do not have to start hedge funds.
https://en.wikipedia.org/wiki/Burton_Malkiel

I think defining experts is an important question to decide how large that pool could be.  I prefer to view academics as experts, because their goal is study rather than drawing in my investment dollars.  Joshua Brown said something interesting on "The Collective" podcast - that as a financial advisor, of course you predict recession.  If you're wrong, nobody cares.  You were being cautious.  But if you say there won't be a recession, and the client loses money, they blame you!  They don't blame the recession.  The risk-reward is all to one side, claiming a recession will occur regardless of odds.  That could be why sentiment seems to be negative, and yet many of the people voicing that sentiment are 90% or more in equities.

Let me use the criteria I seem to be using now: President of a college.
"Lawrence H. Summers is President Emeritus of Harvard University"
"Mohamed A. El-Erian is the President of Queens' College, the University of Cambridge."

Jerome Powell does not even have an economics degree.  The one person having the most impact on the U.S. economy is very far from being an expert.
Jeremy Siegel was an economics professor at Wharton, but not President of any college.  If my criteria is too strict, loosing it would probably include him.

I'm also treating legendary investors as experts on boom/bust cycles, which is a bias on my part.  Emphasis on legendary - investors with over 40 years experience and an impressive investment record.  This should be a separate topic, since it requires evaluating various people in depth.

A bias in the opposite direction is not including Nobel prize winning economists like Paul Krugman.  Consumer preferences seem relevant to predicting inflation, so I really should include him as an expert.  He believes in a soft landing on the strength of the consumer.

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The Prize Committee cited Krugman's work explaining the patterns of international trade and the geographic distribution of economic activity, by examining the effects of economies of scale and of consumer preferences for diverse goods and services
https://en.wikipedia.org/wiki/Paul_Krugman

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I was curious to see how the fire-and-brimstone inflation crowd would react to improving data. To my surprise and slight disappointment, many of them seem to be admitting that a soft landing is possible 3/
https://twitter.com/paulkrugman/status/1616062632707981313

ChpBstrd

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...From 2013-2019, the Fed kept their balance sheet near $4 trillion, and then ran up another more than $4 trillion from 2020-2021.  I think these two injections of liquidity need to be distinguished.  In 2007-2009, the Fed injected liquidity into the largest banking institutions... which didn't lend it out, but kept the money.  It did not reach people's pocketbooks.  In 2020-2021, the U.S. government sent cash directly to Americans.  I think that explains why inflation didn't accelerate after 2007-2009 the way it has after 2020-2021.
https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
Yes, I 100% agree. However I did not foresee this difference in real time. There are lots of posts from me in the summer-fall of 2021 explaining that inflation only seems high because we're returning to normal after a period of disinflation/deflation. So I made the mistake of making excuses for the data, using 2009 as a comparison when the stimulus was not the same, and missing the start of a major trend. I also assumed faster resolution of supply chain issues than actually occurred, perhaps because I was watching everybody in the US go back to work and not paying attention to the more cautious approach being pursued by various Asian and commodity production countries.
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Looking back, it's still surprising that the Fed can inject money into markets and keep it there, fueling one of (or the?) longest bull markets in history.  I understand the simple dynamic at work, but I don't understand how that can be sustained so long... maybe because the borrowing is in U.S. Treasuries, which are the world's reserve currency?  With USD as the world's reserve currency, US Treasuries can be printed and fuel the U.S. stock market?  It seems very speculative to me, but certainly stock market gains went on for a very long time.
I've pondered this as well. The economy is a LOT more complex than Milton Friedman's simple Monetarism can explain. Money supply is not merely the number of dollars in circulation; it matters who holds those dollars and their propensity to spend/invest. This is the lesson of 2009 versus 2020. During and after the GFC, the dollars created to re-capitalize banks and businesses tended to sit in US treasuries for use as collateral or loss reserves, and never made it to main street markets. Ravenous demand for US treasuries as a parking lot for stimulus money actually kept interest rates low, even though the number of dollars in circulation went sky-high. In 2020-2022, however, stimulus money burnt a hole in consumers' pockets, and was quickly turned in the real economy - amid supply chain disruptions.

The answer to the question of how it can be sustained so long also has something to do with the US trade and government deficits. The US has been able to both print dollars and consume more than it produces for decades because those dollars are in demand to fund the growth of the rest of the world. Countries like China need dollars to buy oil, food, and other commodities priced in dollars. Savers in Latin America, the Middle East, Africa, or Southeast Asia create demand for dollars as an alternative store of value compared to their own faster-inflating currencies. The relative stability of the USD helps producers avoid losses to faster-moving currency arbitrageurs and gives them a more stable store of value than any other option. Plus, since everyone else is using USD (network effects) the producer of any particular commodity can use their USD to purchase the imports they need without having to do currency trades (e.g. Saudi Arabia needs food, Italy needs oil, so they swap USD back and forth). 

I don't think most Americans realize their prosperity and ability to hyper-consume is based on nothing more than network effects. If the USD ever stopped being the reserve currency, the US standard of living would fall to Eastern European or Southeast Asian levels very quickly.

Demographic graying is another factor. As people get older, they tend to spend less and less money on most things in the CPI basket. As an entire population gets older, the speed at which an average dollar gets spent, earned, spent, earned... slows down. This is why the velocity of money has been falling since the US' demographic peak in the 1990's:


Tellingly, the main thing older people spend increasing amounts of money on has been one of the fastest growing components of CPI. From 2000 to 2022, healthcare prices rose 110% compared to 71% for all goods and services. This reflects demand outstripping supply in an aging country, and buttresses the argument that three decades of relatively low inflation amid rampant money-printing can be explained by the average American getting older and slowing down their spending.
https://www.healthsystemtracker.org/brief/how-does-medical-inflation-compare-to-inflation-in-the-rest-of-the-economy/#Cumulative%20percent%20change%20in%20Consumer%20Price%20Index%20for%20All%20Urban%20Consumers%20(CPI-U)%20for%20medical%20care%20and%20for%20all%20goods%20and%20services,%20October%202000%20-%20October%202022
 
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Jeremy Siegel wrote "Stocks for the Long Run" back in 1994, and since it has been so long since I read it, I'll quote from Wikipedia's summary:
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Siegel argues that stocks have returned an average of 6.5 percent to 7 percent per year after inflation over the last 200 years
https://en.wikipedia.org/wiki/Stocks_for_the_Long_Run

If he believed that in his book in 1994, and in every edition printed since then, I think it's reasonable for him to believe it in 2000.  I didn't look at his year 2000 comments, but if he simply didn't predict the dot-com crash, and stuck to his "Long Run" belief that stocks rise "7% per year after inflation for the last 200 years", he is essentially being on brand in saying that.
This is a great example of why it's hard to translate academic theoretical reasoning into investment advice. If Siegel's timeframe is measured in generations, it would be incorrect to apply his reasoning to the next couple of months. Similarly, if someone talking about efficient frontier theory says speculative investments have the highest expected returns, it would be a fallacy to go on margin 200% into ARKK because an expert said that's where investors can expect 15%+ returns. Sometimes I even hear people justifying the purchase of very expensive or speculative assets using the efficient markets hypothesis - i.e. Dogecoin cannot be overpriced because a deep and liquid market has digested all the information about it and arrived at its current consensus price. Academic theories are usually extreme generalizations, and the ones which make it into public consciousness are even simpler.

The giant among investment books for that theory is "A Random Walk Down Wall Street".  It was written by Burton Malkiel, who is a "professor of economics at Princeton University".  He might feel hedge funds overcharge and underdeliver, and like teaching.  Multiple websites put his NW at around $1M to $2M, suggesting the websites are wrong or he does not emphasize his NW.  A top investment book writer can decide not to cash in, which is an anecdotal example that professors do not have to start hedge funds.
https://en.wikipedia.org/wiki/Burton_Malkiel
...
I think defining experts is an important question to decide how large that pool could be.  I prefer to view academics as experts, because their goal is study rather than drawing in my investment dollars.  Joshua Brown said something interesting on "The Collective" podcast - that as a financial advisor, of course you predict recession.  If you're wrong, nobody cares.  You were being cautious.  But if you say there won't be a recession, and the client loses money, they blame you!  They don't blame the recession.  The risk-reward is all to one side, claiming a recession will occur regardless of odds.  That could be why sentiment seems to be negative, and yet many of the people voicing that sentiment are 90% or more in equities.

Let me use the criteria I seem to be using now: President of a college.
"Lawrence H. Summers is President Emeritus of Harvard University"
"Mohamed A. El-Erian is the President of Queens' College, the University of Cambridge."

Jerome Powell does not even have an economics degree.  The one person having the most impact on the U.S. economy is very far from being an expert.
Jeremy Siegel was an economics professor at Wharton, but not President of any college.  If my criteria is too strict, loosing it would probably include him.

I'm also treating legendary investors as experts on boom/bust cycles, which is a bias on my part.  Emphasis on legendary - investors with over 40 years experience and an impressive investment record.  This should be a separate topic, since it requires evaluating various people in depth.

A bias in the opposite direction is not including Nobel prize winning economists like Paul Krugman.  Consumer preferences seem relevant to predicting inflation, so I really should include him as an expert.  He believes in a soft landing on the strength of the consumer.
The point of A Random Walk IIRC was that there's no short-term trick to earning the market's returns; just don't buy every mania or sell every panic. There are certainly people in the would who could get rich but choose not to (consumers saving 0% of their massive incomes come to mind) but I don't know how to identify people who choose to appear in the media and whose goal is purely the pursuit of knowledge and not the generation of revenue/fame. Certainly the choice to appear in media, pursue career advancement in academe, or attempting to write bestsellers shows ambition, but I suspect the real truth-seekers are writing economics articles that are unintelligible to outsiders, and which will be read by maybe a dozen people other than the peer reviewers. The motives of those who dumb it down for the rest of us are less clear.

What if their personalities are not about seeking wealth, but are more about seeking influence over others? Would they be more trustworthy as sources of Truth?

I may sound like a Dilbert strip in saying this, but the qualities which lead a person to being promoted to head an academic department probably have little to do with the quality of their research, and more to do with playing the politics correctly or being charismatic. Charisma is also a trait that will get you on CNBC. An academic president spends their time attending meetings, managing HR and budgetary matters, shaking hands at conferences, and creating the sorts of interpersonal alliances that help them keep their jobs or advance to the next level.

The people working on complex equation models and writing SAS scripts to backtest a tweak to a theory that even well-educated laypersons have never heard of are more likely to be graduate students than presidents. The grad student's future depends on their ability to analyze and defend an idea. The president's future depends on their ability to influence others. Seen in this light, a grad student's advice might be better than a university president's.

ChpBstrd

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Recession Indicators List
« Reply #517 on: January 23, 2023, 09:03:15 PM »
As I mentioned before, I'm now more on recession watch than I am on inflation watch. As in the OP, I'm organizing my thoughts about the best data to get warnings about recessions, to obtain confirmation a recession is in progress, and to obtain confirmation a recession is ending.

I'd like to (1) get advance notice when a recession starts, (2) confirm without a doubt a recession is here, and also (3) get a sense of when the turning point occurs, which would be the ideal time to go long.

Of course, if one could get an accurate read on the start date and turning point of a recession, then one could enter a bear spread on a stock index prior to the recession, exit that spread for a big gain, and then enter a bull spread at the end of the recession, earning another big gain on the rebound. That would be a 200+% gain for two well-timed ATM spreads. A more conservative play would be to just ride the recession in cash/treasuries and get back into stocks when the recession is going badly, thus avoiding a major Sequence of Returns Risk Event. Call it a fool's errand if you want, but let's look at the sorts of data we have at our fingertips:

Advance Recession Signals

10y/2y yield curve
This classic yield curve seems to offer the most advanced warning of a recession. This signal has enjoyed great predictive accuracy in the past, and offered investors ample lead time unlike many other signals. A brief and shallow false signal occurred in 1998 during the Asian financial crisis, but other than that the 10/2's record remains strong in the past half-century. A strong signal has always meant recession is on the way, but it can take over a year to arrive. The 10/2 inverted on July 6, 2022 and remains deeply inverted today. Today's -0.66% spread is the largest since 1981.


10y/3m yield curve
The 10y/3m curve is an even more reliable recession warning than the 10/2 with the last failure occurring in 1967 in a very different economy (gold standard, no dual mandate, no QT/QE). If investors are willing to accept lower yields to take on 10 years of duration risk rather than 3 months, that means they expect something bad to happen and rate cuts to arrive soon. It's an extreme inversion of the normal premium borrowers must pay to borrow for longer periods. Also note how both the 10y/2y and 10y/3m tend to un-invert a few months before the start of recession, providing a false dawn or calm before the tsunami. This indicator is warning of recession within the next year or so.


A 300+bp Federal Funds Rate Increase
By the beginning of February, the FFR will have gone from a higher bound of 0.25% to 4.75%. There has not been a period in modern economic history where rates rose by at least 450bp within a couple of years and a recession failed to follow. 2020 followed a roughly +225bp campaign. 2008 followed a roughly +425bp campaign. 2001 followed a roughly +189bp increase. Rate hikes must be sufficiently large to cause a recession. The threshold of uncertainty appears to be somewhere just above 300bp. At or below that level of rate hikes, it appears the economy is capable of surviving without a recession, but above it abandon all hope! Between 1993 and 1995 there was a roughly 3% rate hike and a recession did not follow. Similarly, between 1983 and 1984 rates increased by about 3% and nothing happened. Rate hikes often precede recessions by a year or more. The last 4 recessions began after the Fed already started cutting rates, so simply following the Fed and going long as the rate cuts start is not a viable strategy. According to this indicator, the odds of a recession this year or next are nearly certain.

Conference Board Leading Economic Indicators (LEI) index
This composite index offered advance warning of the 2001 and 2007-2008 recessions, and quickly signaled recession when the pandemic hit in 2020. It appears to offer a couple months of advance notice when a once-in-a-century pandemic-scale crisis is not occurring. There also seems to be a reliable "recession-is-over" signal because the coast seems to be clear when the LEI returns to zero percent. Currently the LEI index is signalling recession because it has fallen below the Conference Board's "recession warning" threshold.

National Financial Conditions Index
Banks and investors tend to tighten their lending standards when a recession is around the corner. The NFCI purports to measure the ease or difficulty of obtaining financing by combining a variety of spreads and swaption volatility into an index. When the NFCI rises above zero (it is normally negative) a recession is on the way. The NFCI is one of the more reliable recession predictors, but the timing between the signal and the recession's start is highly variable. Even worse, the NFCI made several false recession calls in the 80s and then missed the 2001 recession completely. Nonetheless, there's a direct conceptual link between tighter financial conditions and negative growth so we should pay attention.


Collapsing Natural Gas Prices
Natural gas has historically run up ahead of recessions and then crashed just as the recession took hold. That was the case in 2001 and 2007-2008. However, gas prices also peaked in 2003, 2004, and 2005 with no associated recession. Currently, gas prices peaked in August 2022 and are now plummeting. It's probably too late to prepare for recession by shorting UNG.

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Real Time Recession Signals

Initial claims
When people were claiming that two consecutive quarters of negative GDP growth in 2022 meant a recession had occurred, I said "it's not a recession if nobody loses their job." It wasn't a recession either, because job growth actually occurred! To identify the start of this next recession, I'm looking for an increase in initial claims from last week's 190k/week (a historically low-water mark) to 330k to 350k (numbers reached just before the GFC, 2001 recession, and 1991 recession). If weekly initial claims rise to those levels, it means the recession is almost here. Today's super-low initial claims number suggests the recession might be a long time coming.


Private Residential Fixed Investment
Dips in residential investment have preceded most recessions since at least the late 1940s. The pattern has been for a decline in housing investment to precede a recession by a quarter or two, although there have been exceptions. When residential investment falls by about 5% or more, a recession is imminent or in progress. The combination of lower reliability (than say, yield curves) and the information arriving almost too late to make a difference (it's part of the GDP report) make this more of a recession confirmation metric than a predictor. Residential investment tends to recover in the second half of a recession.


CNN Fear & Greed Indicator
This is an aggregate of stock price momentum & breadth, 52 week highs vs lows, puts vs calls, volatility, last 20 day stock vs. bond returns, and junk bond spreads. The resulting indicator is very noisy, but provides context to investor activity. During a recession, the best only times to buy would be "extreme fear" times.

University of Michigan Consumer Sentiment Survey
Look at the 50-year chart of the Consumer Sentiment Survey and notice how sentiment plunges at the start of a recession. Also note that sentiment does not tend to improve until the recession is basically over. Thus, I suggest using consumer sentiment as a tool to identify the start of a recession. Today's sentiment has fallen to levels last seen during the GFC, but appears to be staging a recovery. So maybe the recession is close? This diagnosis would conflict with the patterns usually seen with yield curves.

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Recession Exit Signals

University of Michigan Current Economic Conditions Survey
Unlike the U of M's consumer sentiment survey, the economic conditions survey seems to be an excellent indicator of when the end of a recession is imminent. See the 50 year chart. Consumers may be grumpy (sentiment) but they have a collective finger on the pulse of the economy and seem to know when economic conditions start to turn around. Of course, some credibility is lost when we note that consumers think the economy is worse today than it was during the GFC or the early 1980s, and yet unemployment is now only 3.5%. Jeez, what would they think if the economy was actually bad?

The NFCI, again.
Note how the NFCI typically plummets at some point in the recession, and by the time it hits zero again the recession is over. This provides an end-of-recession signal that arrives faster than the NBER recession declaration.

Conference Board Leading Economic Indicators (LEI) index, again
The LEI has historically leapt back up toward zero, arriving at zero sometime after the recession has ended. This provides an end-of-recession signal that arrives faster than the NBER recession declaration.

« Last Edit: January 24, 2023, 01:53:23 PM by ChpBstrd »

MustacheAndaHalf

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I don't think most Americans realize their prosperity and ability to hyper-consume is based on nothing more than network effects. If the USD ever stopped being the reserve currency, the US standard of living would fall to Eastern European or Southeast Asian levels very quickly.
... if someone talking about efficient frontier theory says speculative investments have the highest expected returns, it would be a fallacy to go on margin 200% into ARKK because an expert said that's where investors can expect 15%+ returns. Sometimes I even hear people justifying the purchase of very expensive or speculative assets using the efficient markets hypothesis - i.e. Dogecoin cannot be overpriced because a deep and liquid market has digested all the information about it and arrived at its current consensus price.
I can't resist a setup like that, with two references to a great Remy parody.

Civilian: "We pay our debts in our currency, that might be unfurled
if it's no longer the reserve currency of the world."

Mr Jackson: "Confidence in the dollar is permanent, just ask any scholar!"

Civilian: "People are exchanging their dollars for dog money."

https://www.youtube.com/watch?v=cbI31x3FpS0&t=109s

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Back in March 2020, experts were much easier to identify: infectious disease experts, who saw Covid-19 coming before the U.S. stock market.  In 2023, experts are much noisier, and I may need to revisit my criteria.  Personally, I'm tired of active investing, and want to put in less effort, which is a headwind to actually figuring it out.

Graduate students tend to study the differences in economics between certain types of beans in Southern Peru.  They lack context.  President of a college could be purely political, but it also reflects long experience and respect in their field.  They have much more breadth of knowledge and experience to use, which I suspect would give them an advantage over graduate students.  But a study would settle the matter - if anyone was brave enough in academia to do that study?  ("Why the President of the college I attend knows less than I do"?)

I read Mohammed El-Erian's wikipedia page, and it's impressive - much greater than just President of a college.  He has been ranked as a top economist, CEO at PIMCO, CEO of Harvard's Endowment (the billions they invest), President's council on development, and others.  I thought he also contributed an idea to make an "El-Erian portfolio", but didn't find that.

Larry Summers was also Treasury Secretary, Chief Economist at the World Bank, and generally more controversial than El-Erian.  I wonder if he has been ranked on one of the top economist lists, like El-Erian?  That could prove a helpful starting point.

While using "Nobel Prize winners in Economics" certainly means experts in economics, it may not be macro economics and inflation.  I picked Paul Krugman as an example because his work related to consumer behavior, which makes him a clearer pick (and one who believes in a soft landing, where I'm only half convinced).  Expanding that list, and deciding who worked in macro economics could be another approach.

And then we have to score them all... figure out who gets macro events correct more often than not, and that is probably hard work as well.

Most fund managers are 90% equities, while I'm 90% cash.  The other 10% consists of put options in SPY and QQQ, and a small allocation to TMV.  When the market goes up, I lose about 2/3rds of the gain (QQQ moves further than SPY).  I'm tired of active investing, and waiting for a good moment to move back into the market.  The current level of the market is justified if there's no recession, but anything else could cause it to fall - even time passing.  So if I do the research I mention above, I expect it is only worthwhile for a matter of months.

Your post mentioned the timing of the recession.  I recall a prediction from ?Bank of America? that shifted from 2022 Q1 to 2022 Q2 for the start of recession, based on current data.  Credit Suisse expects it in 2022 Q4, give or take a month.  Even though this is being called the most expected recession, we may know more in just over 2 months, or have to wait a year.  The market uncertainty is over when, and then somewhat over what happens.

ChpBstrd

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@MustacheAndaHalf let's also think about some of the experts who aren't on CNBC every other day.

Stephen Roach, the former Fed economist during the 1970s was advocating positive real interest rates - although perhaps not going as far as to recommend the +4% real rates he saw under Paul Volker - and he was advocating massive rate hikes back in April and May of 2022 when most media personalities were pondering if a 2.5% FFR would be the "neutral rate". Looking further back, Roach was raising the alarm about inflation back in 2020. Roach correctly predicted back in May that inflation would be >5% by the end of 2022, and the FFR would not exceed 5%. That's saying a lot given the level of policy uncertainty back then.
https://www.marketwatch.com/story/i-knew-paul-volcker-who-slew-the-great-inflation-and-jerome-powell-is-no-paul-volcker-11653500709?mod=hp_minor_pos26
https://www.dailymail.co.uk/news/article-10045537/Supply-chain-crunch-rising-cost-crude-oil-collision-course-inflation.html
https://www.cnbc.com/2022/05/19/stephen-roach-gives-stagflation-warning-calls-peak-inflation-absurd.html

However, Roach has been fairly quiet recently, and more focused on Chinese-US relations (arguably a bigger issue than inflation). He did not appear to call the sudden collapse in inflation which started in July 2022, which is a glaring omission.  Yet his forecasts for 1970s levels of inflation may still prove correct in the end, as we could be going through a multi-year cycle of recession and inflation with lots of false dawns just like the 70's. Powell's repeated statements that he's looking for positive real interest rates as a signal to pause the rate hikes may have been inspired by Volker's experience, and some unfriendly prodding from Roach.

James Bullard lost his vote on the FOMC this year, but has been a vocal advocate of the Taylor Rule, presenting multiple times in 2022 with slides showing how the rule prescribes rate hikes far in excess of the contemporary chatter. In early April 2022, Bullard illustrated the ridiculousness of then-current expectations by showing how even using a trimmed mean definition of inflation (i.e. cutting out the outliers, like Arthur Burns did) you still get a prescription for a 3.5% FFR, and by implication if one applied headline PCE, like the FOMC actually uses, you could add at least 2% to that! In November 2022, Bullard said we should expect rates between 5% and 7%, which came as a surprise to the 5% consensus.
https://www.stlouisfed.org/news-releases/2022/04/07/bullard-discusses-is-the-fed-behind-the-curve
https://www.cnbc.com/2022/11/17/feds-bullard-says-rate-hikes-have-had-only-limited-effects-on-inflation-so-far.html
https://www.stlouisfed.org/-/media/project/frbstl/stlouisfed/files/pdfs/bullard/remarks/2022/nov/bullard-louisville-17-nov-2022.pdf?sc_lang=en&hash=4725A924300B1A6777E788822AF33277

Bullard has been consistently right about the trajectory of interest rates, but he too failed to call the disinflation of 2H2022 ahead of time. This is an especially damming omission because of the implied precision of his mathematical approach, and the underlying assumption of the Taylor Rule that inflation only goes down when we have positive real interest rates. Well, actually inflation just dropped despite deeply negative real yields. Bullard had an influence on me, which may be why I too was slow to catch on to the disinflationary trend.

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

There's no theoretical reason why the 2-4%ish rates should have knocked down PCE that had been running at 9.26% in June. Policy was highly stimulative according to the Taylor Rule, Keynesian theory, and arguably Monetarist theory too. We can blame falling commodity prices, consumers running out of stimulus money, and improving supply chains for the disinflation. This is a case where the simplistic theories of experts were overwhelmed by a confluence of causes.

I also think quantitative tightening had a lot to do with it - the timing was just right. This is another reason I suspect QT is more powerful medicine than the Fed or most other observers think. There's also the 2018 and "taper tantrum" experiences, where QT or even talk of QT or even talk of ending QE set off mild panics and corrections. The 2018 QT was only a couple hundred billion dollars total, but almost set off a recession, and led to a deflation which took 4 months to recover, as annual PCE fell 2%. This time, QT may have been powerful enough to knock down high inflation despite negative real rates incentivizing people to pull ahead purchases.

Treasury markets might function as a sort of one-way money valve, where QE (-bonds, +cash) dollars easily overflow into other areas of the economy but where QT (+bonds, -cash) forces the banking sector to either find new deposits or cut back their lending as they become bond rich and cash poor.

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Treasury markets might function as a sort of one-way money valve, where QE (-bonds, +cash) dollars easily overflow into other areas of the economy but where QT (+bonds, -cash) forces the banking sector to either find new deposits or cut back their lending as they become bond rich and cash poor.

This intuitively sounds plausible. Curious to see if it proves to have predictive power.

vand

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Re: Recession Indicators List
« Reply #522 on: January 24, 2023, 01:59:59 PM »
As I mentioned before, I'm now more on recession watch than I am on inflation watch.

Yep. 2022 was the year to worry about inflation and interest rates. For 2023 the narrative will move onto layoffs and economic weakness/recession.

It has to be said, though, that it usually doesn't pay to follow the consensus, and the consensus is pricing in a mild recession right now.  So I think we will either do better than consensus forecasts, or we will have a much deeper recession than people are expecting.  Honestly no idea what side of that I'd go with right now.
« Last Edit: January 24, 2023, 02:03:05 PM by vand »

MustacheAndaHalf

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@MustacheAndaHalf let's also think about some of the experts who aren't on CNBC every other day.
I don't think a Nobel Laurete, a President of a Cambridge College and a former Treasury Secretary should be belittled as simply people who are "on CNBC every other day".

ChpBstrd

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Re: Recession Indicators List
« Reply #524 on: January 24, 2023, 07:25:59 PM »
As I mentioned before, I'm now more on recession watch than I am on inflation watch.

Yep. 2022 was the year to worry about inflation and interest rates. For 2023 the narrative will move onto layoffs and economic weakness/recession.

It has to be said, though, that it usually doesn't pay to follow the consensus, and the consensus is pricing in a mild recession right now.  So I think we will either do better than consensus forecasts, or we will have a much deeper recession than people are expecting.  Honestly no idea what side of that I'd go with right now.

Let's think through the consequences of making a Type 1 or Type 2 error in our investment decisions right now. A Type 1 error is investing like a recession will occur when it actually will not. A Type 2 error is investing like a recession will not occur, when actually it will.

Let's make the decision time-bound so that the recession must occur or not occur within the next 18 months (deadline: July 2024).

If we invest like a recession will occur, let's say we will load our "recession portfolio" 100% with 10-year treasuries yielding 3.5%.
     Recession DOES occur: Earn 3.5%, plus any capital appreciation due to lowered rate expectations or rate cuts (let's assume zero to keep it clean).
     Recession DOES NOT occur: Earn 3.5%, miss out on bull portfolio returns of 15%.

If we invest like a recession will NOT occur, let's say we hold a "bull portfolio" of 80% VTI, 20% BIV.
     Recession DOES occur: Lose 18%, net of dividends.
     Recession DOES NOT occur: Earn 15%

If we were on the fence and assigned 50% odds to either outcome, the expected performance of each portfolio is:
     Recession Portfolio = (50% * 3.5%) + (50% * 3.5%) = 3.5%
     Bull Portfolio = (50% * -18%) + (50% * 15%) = -1.5%

If we think the odds of recession are 75%, then...
     Recession Portfolio = (75% * 3.5%) + (25% * 3.5%) = 3.5%
     Bull Portfolio = (75% * -18%) + (25% * 15%) = -9.75%

Obviously one can add their own probabilities, change the expected returns, and make up more scenarios such as mild vs severe recession. The point is that assigning any significant odds of another ~20% stock correction devastates the expected performance of a bullish portfolio.

Almost all our metrics aside from initial claims are pointing toward economic contraction in a way they haven't done since the GFC, so I think assigning majority odds to the recession scenario makes sense. Even in my first scenario with 50/50 odds, the recession portfolio still wins. To be clear I'm not advocating that we regularly assign such high odds to recession. The vast majority of years have positive returns. But there's rarely a confluence of so many metrics and factors indicating recession as there is today.

MustacheAndaHalf

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Just to unify our discussion on experts, I would say pick any criteria for "expert", but then apply it to articles.  If I see an opinion piece by someone I don't recognize, I need to check their background.  Most likely, they are a writer who has never run any investment money or had any background in economics.  Discarding the 80% of article writers who are not experts is more important than finding a few experts.

Legendary investor Lee Cooperman provided estimates of the S&P 500 in three different places: 3000-3600 (50%), 3600-4400 (45%), 4400+ (5%).  He specifically said not to ignore the 4400+ low chance high impact case, but I'm afraid I need to start with the simplified case: a coin flip as low as 3000, or as high as 4400.  The S&P 500 index is 4060 after Thursday's +1% move.  The middle of those ranges would mean either -18.7% or -1.5% from here, both negative.  The extreme outcomes are -26.1% (to 3000) and +8.3% (to 4400).  Mr Cooperman's expectations suggest risk to the downside for 2023.

I think this market strings investors along, making them wait for each event longer than they expected.  Yesterday 2022 Q4 GDP came in at 2.9%, meaning no recession as of December.  The stock market is on recession watch, with consensus of Q1/Q2 ... but I haven't checked for updates since GDP was released.  If things drag out, the past 6 months (-12% to +6% range) could define the next 6 months.

There's another factor to consider: inflation may be 3% for years after a recession.  Companies shifting away from China, Europe finding other energy sources... both involve shifting from the lowest cost supplier.  Both involve higher prices, which means mildly higher inflation.  That could impact tech stocks, which were priced for easy money and very low inflation.  Tech stocks could make a recovery, but stall to price in slightly higher inflation for years ahead.

ChpBstrd

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Just to unify our discussion on experts, I would say pick any criteria for "expert", but then apply it to articles.  If I see an opinion piece by someone I don't recognize, I need to check their background.  Most likely, they are a writer who has never run any investment money or had any background in economics.  Discarding the 80% of article writers who are not experts is more important than finding a few experts.

Legendary investor Lee Cooperman provided estimates of the S&P 500 in three different places: 3000-3600 (50%), 3600-4400 (45%), 4400+ (5%).  He specifically said not to ignore the 4400+ low chance high impact case, but I'm afraid I need to start with the simplified case: a coin flip as low as 3000, or as high as 4400.  The S&P 500 index is 4060 after Thursday's +1% move.  The middle of those ranges would mean either -18.7% or -1.5% from here, both negative.  The extreme outcomes are -26.1% (to 3000) and +8.3% (to 4400).  Mr Cooperman's expectations suggest risk to the downside for 2023.

I think this market strings investors along, making them wait for each event longer than they expected.  Yesterday 2022 Q4 GDP came in at 2.9%, meaning no recession as of December.  The stock market is on recession watch, with consensus of Q1/Q2 ... but I haven't checked for updates since GDP was released.  If things drag out, the past 6 months (-12% to +6% range) could define the next 6 months.

There's another factor to consider: inflation may be 3% for years after a recession.  Companies shifting away from China, Europe finding other energy sources... both involve shifting from the lowest cost supplier.  Both involve higher prices, which means mildly higher inflation.  That could impact tech stocks, which were priced for easy money and very low inflation.  Tech stocks could make a recovery, but stall to price in slightly higher inflation for years ahead.
I do think the universe is best summed up as "a normal distribution" but I am reluctant to apply statistical thinking to (a) forecasts and (b) of something with millions of input sensitivities like the stock market. The risks are that we let our own biases tip the scales, and we assume the single and deterministic future is a dot somewhere in the middle of the last few years' volatility range, as centered on today's numbers. I'm not as skeptical of forecasting as Nassim Taleb, who seems to treat the future as chaotic and unknowable, but I can also see when we're simply overlapping a bell curve atop today's numbers and calling it a forecast. It takes an expert to do that, but all they're doing is applying a theory that seems to work most of the time. At this point we can't even tell whether good economic news will make the market go up or down the next day, much less pin down a year from now.

The GDP numbers, durable goods orders, initial claims, velocity of M2, etc. numbers DO NOT suggest anything like a recession. However they wouldn't necessarily provide an advance signal either. By the time we see negatives on those metrics, the recession will already be half over. Things dragging out is one of my key concerns. If the March or April numbers look like the December numbers, then why won't we see forward guidance about 0.25% rate hikes in May and June? We can't say James Bullard and a lot of other experts didn't warn us.

I'm playing the expert myself, looking at various data sources (see list above) to see how much advance warning they typically provide. E.g. the 10y/2y yield curve inversion and the 2y/FFR inversion have each offered an average 15 months of advance warning.
https://seekingalpha.com/article/4499237-this-indicator-warns-for-a-looming-recession

We're currently on month 10 for the 10/2, and month 2 for the 10/FFR. Thus we can - theoretically - say that the 10/2 predicts a recession in 5 months, the 10/FFR predicts a recession in 13 months, and the mean of those two predictions is a recession in 9 months (prediction = October 2023). I could do something similar for the NFCI, the LEI, natural gas or petroleum prices, manufacturing reports, residential investment, or fed rate hikes beyond a certain threshold such as 2.5%. Adding more data to the model makes it more convincing!

Would I bet on these specific dates? No.

What has gone unwritten here so far is that my projection would assume reversion to the mean (when in fact each data element is quite variable and the means have changed with each recession), and I've also not mentioned that I didn't count several yield curve inversions not followed by a recession, such as in the mid-90s. I've also not weighted each of my two data elements by their past reliability, variance, or for current circumstances such as money supply contraction or issues with housing. Some numerical noise has been made to converge on an answer, but what matters is not the answer, it's the validity of trying to predict the timing of a recession this way. We don't generally get so much nuance from expert/pundits.

For all I know the 10/FFR will be the best predictor this time, and it'll run past 20 months as it did 2 out of the past 8 times, and the recession won't come until 18-19 months from now (mid-2024!). Yet my predictions of a late-2023 recession start date give me something to think about as I position for a recession that might take over a year to arrive or could come at any moment. It helps me decide whether I should park cash in 6 months treasuries, 12 month treasuries, or a money market account. It helps me think about the possibilities of a >5% FFR and what assets, if any, I want to be holding when the SHTF so that I can pivot into risky assets on the cheap.

Re: De-globalization, I think trade will return to China a lot faster than expected because they remain the low-cost producer for most things. They already have the infrastructure and human capital, and will reopen quickly (to the extent they ever "closed"). Little has actually changed with trade policy since Trump's tariffs. Technology export restrictions from the US are laughable when the technology is actually made in China. US chip plants may suffer the same fate as the factories which were quickly set up to manufacture N95 masks in 2021, and were promptly undercut by the availability of cheaper/better imports and a lack of government support.

It's also not necessarily true that Europe is switching to higher-cost energy supplies. If the Russian gas issues persuade Europeans to make upfront investments in renewables, they might end up with a power source that is less costly in the long run. Solar and wind power are already cheaper than fossil fuels in most cases - they just have frontloaded cost structures. Plus, if Europe decouples their economies from volatile energy prices, they could become more recession-resistant in the long run. This decoupling and energy price leadership could eventually mean more inflows of global investment and less strain on the social safety net. Russia might have been just the stimulus Europe needed to quit making payments on energy imports and to put the money down to own their own energy production.

MustacheAndaHalf

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ChpBstrd - I actually tried to place a normal distribution over Lee Cooperman's numbers to get a sense of outcomes he envisions, with the center 2/3rds at the center of his two coin flips.  But his comment about a 5% chance of over 4400 also captures an important aspect of markets: they do not follow normal distributions.

Quote
In the "Black Monday" stock market crash of Oct. 19, 1987, U.S. markets fell more than 20% in a single day.
https://www.investopedia.com/ask/answers/042115/what-caused-black-monday-stock-market-crash-1987.asp

If you try and plot that flash crash on a normal distribution, I recall you wind up dozens of standard deviations away - an essentially impossible event.  And those impossible events happen too often to explain, except if you break the normal distribution and accept "kurtosis", or higher probability extreme outcomes.  I think it's also important to price in the risk of an average recession, which a normal distribution could underestimate.

Larry Summers is a contributor on Wall Street Week, but also a Harvard Economist and former US Treasury Secretary.  He knows this material better than me, and feels (increasing) inventories contributed a lot to the GDP numbers.  He thinks overall the economy is more mixed, and the Fed should retain maximum flexibility - not talk confidently about future intentions.  He expects a 0.25% rate hike.
https://www.youtube.com/watch?v=ZsdlVNCoiMQ

Harry Truman is quoted as saying
Quote
'Give me a one-handed Economist. All my economists say 'on hand...', then 'but on the other...'
Another economist predicts an up and down inflation rate, where central banks keep using QE measures and lower rates, then raising rates as appropriate.  The claim is that technology is disinflationary and more impactful than other inflationary factors.

Mr Summers points to four inflationary factors, including a green energy transition (which requires investment).  You mention that as well, and I don't think that will be very far underway by next winter.  Europe will need oil & gas from somewhere other than Russia by then.

I think your claim of exactly 15 months delay for a 10y/2y yield inversion has two areas of concern.  First, we know for certain the recession did not start within the first 9 months, so you can eliminate recessions that started within that time frame, and take the average of the rest.  But taking a single number, instad of a range, is probably using accuracy that the data doesn't show.  Also, I believe 10 year / 3 month is an even stronger signal, although tends to trigger after market losses have already started.

Mr. Green

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #528 on: February 03, 2023, 10:27:02 AM »
Woooow, that jobs report! 517,000 jobs added in the month of January. Lowest unemployment since man walked on the moon. That was a flaming bag of dog shit left on Mr. Inflation-Is-In-Hand's porch. The mixed signals are truly incredible, and my hat is off to any active investor that has the fortitude to wade through it all and come out with enough confidence to make plays. I think I'd just kick back and take a siesta for a month or three.

SpaceCow

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #529 on: February 03, 2023, 10:35:58 AM »
Woooow, that jobs report! 517,000 jobs added in the month of January. Lowest unemployment since man walked on the moon. That was a flaming bag of dog shit left on Mr. Inflation-Is-In-Hand's porch. The mixed signals are truly incredible, and my hat is off to any active investor that has the fortitude to wade through it all and come out with enough confidence to make plays. I think I'd just kick back and take a siesta for a month or three.

Plus, Jerome Powell talks hawkishly about future hikes, and stocks soar. I don't know what to make of any of this.

EscapeVelocity2020

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #530 on: February 04, 2023, 10:31:07 AM »
All That Recession Talk Is Looking More and More Like CEO Fear-Mongering

Quote
January’s unemployment rate was 3.4%, a 50-year low, as the U.S. economy added 517,000 jobs, according to the Bureau of Labor Statistics—more than double the 188,000 that economists had expected. Aside from the information sector, which contains both tech and media and lost 5,000 jobs from last month, just about every other industry added thousands of jobs—or hundreds of thousands, in the case of leisure and hospitality companies.
...
Many economists cite inflation as the reason to worry about a recession, since the Federal Reserve will increase interest rates to fight inflation, making the cost of borrowing higher. But inflation is also a sign that the economy is pretty strong. Inflation happens, by and large, when too much money is chasing too few goods; in recent months U.S. consumers flush with cash spent so much money that companies couldn’t keep up. (Arguably CEOs contributed to inflation as well by increasing prices.) The Federal Reserve responded over the last year by raising interest rates at the fastest rate since the 1980s. That makes money more expensive to borrow—for consumers who might want to buy cars or homes, but also for big companies.

So basically, if it weren't for CEO's overreacting with preventive measures, job growth would be even stronger!  And this message is apparently what has allowed wage growth to remain in check, workers fearing job loss more than wages not keeping up with inflation, but how long can this last?



 

ChpBstrd

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #531 on: February 05, 2023, 08:35:31 AM »
All That Recession Talk Is Looking More and More Like CEO Fear-Mongering

Quote
January’s unemployment rate was 3.4%, a 50-year low, as the U.S. economy added 517,000 jobs, according to the Bureau of Labor Statistics—more than double the 188,000 that economists had expected. Aside from the information sector, which contains both tech and media and lost 5,000 jobs from last month, just about every other industry added thousands of jobs—or hundreds of thousands, in the case of leisure and hospitality companies.
...
Many economists cite inflation as the reason to worry about a recession, since the Federal Reserve will increase interest rates to fight inflation, making the cost of borrowing higher. But inflation is also a sign that the economy is pretty strong. Inflation happens, by and large, when too much money is chasing too few goods; in recent months U.S. consumers flush with cash spent so much money that companies couldn’t keep up. (Arguably CEOs contributed to inflation as well by increasing prices.) The Federal Reserve responded over the last year by raising interest rates at the fastest rate since the 1980s. That makes money more expensive to borrow—for consumers who might want to buy cars or homes, but also for big companies.

So basically, if it weren't for CEO's overreacting with preventive measures, job growth would be even stronger!  And this message is apparently what has allowed wage growth to remain in check, workers fearing job loss more than wages not keeping up with inflation, but how long can this last?
I don’t think the recession fears are just talk, or just a media narrative. The Federal Reserve did actually raise interest rates 4.5% in the span of just 11 months, and that level of rate increases has never NOT been followed by a recession in all of modern economic history.

Plus, recessions are typically preceded by a burn-up period of strong performance. If the unemployment rate is 3.4% it can’t go down much further.

If anything, the jobs report debunks the media’s approach of focusing on specific layoff events in a wider environment of vigorous hiring.

Mr. Green

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #532 on: February 05, 2023, 12:00:39 PM »
All That Recession Talk Is Looking More and More Like CEO Fear-Mongering

Quote
January’s unemployment rate was 3.4%, a 50-year low, as the U.S. economy added 517,000 jobs, according to the Bureau of Labor Statistics—more than double the 188,000 that economists had expected. Aside from the information sector, which contains both tech and media and lost 5,000 jobs from last month, just about every other industry added thousands of jobs—or hundreds of thousands, in the case of leisure and hospitality companies.
...
Many economists cite inflation as the reason to worry about a recession, since the Federal Reserve will increase interest rates to fight inflation, making the cost of borrowing higher. But inflation is also a sign that the economy is pretty strong. Inflation happens, by and large, when too much money is chasing too few goods; in recent months U.S. consumers flush with cash spent so much money that companies couldn’t keep up. (Arguably CEOs contributed to inflation as well by increasing prices.) The Federal Reserve responded over the last year by raising interest rates at the fastest rate since the 1980s. That makes money more expensive to borrow—for consumers who might want to buy cars or homes, but also for big companies.

So basically, if it weren't for CEO's overreacting with preventive measures, job growth would be even stronger!  And this message is apparently what has allowed wage growth to remain in check, workers fearing job loss more than wages not keeping up with inflation, but how long can this last?
I don’t think the recession fears are just talk, or just a media narrative. The Federal Reserve did actually raise interest rates 4.5% in the span of just 11 months, and that level of rate increases has never NOT been followed by a recession in all of modern economic history.

Plus, recessions are typically preceded by a burn-up period of strong performance. If the unemployment rate is 3.4% it can’t go down much further.

If anything, the jobs report debunks the media’s approach of focusing on specific layoff events in a wider environment of vigorous hiring.
What makes this so fascinating to armchair quarterback is that this time is different. The trend toward globalization over the last 30 years and all the knock on effects of the pandemic (supply chain issues, etc.) have made the state of things quite a mess to make heads or tails of. Even though we know recessions lag interest rate hikes it's hard to imagine going from "lowest unemployment rate in almost 55 years" to recession and that's after the Fed has already raised rates more in the span of 12 months than any recent recession-causing series of hikes.

bmjohnson35

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #533 on: February 05, 2023, 03:25:05 PM »
All That Recession Talk Is Looking More and More Like CEO Fear-Mongering

Quote
January’s unemployment rate was 3.4%, a 50-year low, as the U.S. economy added 517,000 jobs, according to the Bureau of Labor Statistics—more than double the 188,000 that economists had expected. Aside from the information sector, which contains both tech and media and lost 5,000 jobs from last month, just about every other industry added thousands of jobs—or hundreds of thousands, in the case of leisure and hospitality companies.
...
Many economists cite inflation as the reason to worry about a recession, since the Federal Reserve will increase interest rates to fight inflation, making the cost of borrowing higher. But inflation is also a sign that the economy is pretty strong. Inflation happens, by and large, when too much money is chasing too few goods; in recent months U.S. consumers flush with cash spent so much money that companies couldn’t keep up. (Arguably CEOs contributed to inflation as well by increasing prices.) The Federal Reserve responded over the last year by raising interest rates at the fastest rate since the 1980s. That makes money more expensive to borrow—for consumers who might want to buy cars or homes, but also for big companies.

So basically, if it weren't for CEO's overreacting with preventive measures, job growth would be even stronger!  And this message is apparently what has allowed wage growth to remain in check, workers fearing job loss more than wages not keeping up with inflation, but how long can this last?
I don’t think the recession fears are just talk, or just a media narrative. The Federal Reserve did actually raise interest rates 4.5% in the span of just 11 months, and that level of rate increases has never NOT been followed by a recession in all of modern economic history.

Plus, recessions are typically preceded by a burn-up period of strong performance. If the unemployment rate is 3.4% it can’t go down much further.

If anything, the jobs report debunks the media’s approach of focusing on specific layoff events in a wider environment of vigorous hiring.
What makes this so fascinating to armchair quarterback is that this time is different. The trend toward globalization over the last 30 years and all the knock on effects of the pandemic (supply chain issues, etc.) have made the state of things quite a mess to make heads or tails of. Even though we know recessions lag interest rate hikes it's hard to imagine going from "lowest unemployment rate in almost 55 years" to recession and that's after the Fed has already raised rates more in the span of 12 months than any recent recession-causing series of hikes.

It is crazy times indeed and probably anybody's guess how it will play actually out.  Despite the employment data, I still think that a correction, followed by a recession, is inevitable at this point.  Globalization isn't as attractive as it once was and countries are moving toward more protectionist policies. This will change the global supply chain landscape a bit. As inflation remains sticky, globalization adapts and the cost of debt continues its pressures, I think it will turn south before the end of 2023.  Since my guess is no better than anyone else's, I plan to conservatively speculate.  Although I had considered starting off at 60/40 stocks/bonds, I have decided to start at 70/30 this year. If we do see a significant correction, I will start shifting toward a higher percentage of stocks as opportunities arise. I haven't ever went higher than 80/20, but if the right opportunities arise, I would go up to a 90/10 mix. If it simply bounces around and doesn't make significant moves, I will leave it as-is.

All of the above pertains to my longer-term retirement account.  Our taxable account is around 75/25.  It's generally left alone due to ACA income restrictions. VTSAX just got high enough to equate to an average of 8% annual return over the past 3 yrs, so I decided to go ahead and take what we needed for the rest of 2023. I had planned to take equal monthly withdrawals this year, but figured it was better to just make a move.

ChpBstrd

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #534 on: February 06, 2023, 08:24:57 AM »
I dunno. I'll buy into the End Of Globalization narrative when I see "made in USA" flat screen displays and cell phones, when Saudi Arabia has trouble finding buyers for its oil, and when US budget deficits are sustainably less than $400B per quarter.


ChpBstrd

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #535 on: February 09, 2023, 10:14:39 AM »
Here is a great read about the falling money supply, which has been a major concern of mine:

https://finance.yahoo.com/news/central-banks-fighting-wrong-war-060000693.html

Quote
“Inflation and growth are slowing more dramatically than many believe,” said Larry Goodman, head of the Center for Financial Stability in New York, which tracks ‘divisia’ measures of money.

Broad divisia M4 is in outright contraction. He said the fall now dwarfs the largest declines seen during Paul Volcker’s scorched-earth policy against inflation in the late 1970s.

Regarding the UK central bank:
Quote
...the picture is eerily similar to events in mid-2008 when the consensus thought the economy would muddle through with a light downturn and no need for a big change in policy.

They were unaware that the growth rate of real narrow M1 money (six-month annualised) was by then plummeting at an annual rate of around 12pc.

Quote
Personally, I am more Keynesian than monetarist, but the monetarists were right in warning of an unstable asset boom in the mid-Noughties, they were right in warning about the pre-Lehman contraction of money that followed, they were right about pandemic inflation, and I fear that they about right the monetary crunch developing in front of our eyes.

We are told that almost “nobody” saw the global financial crisis coming in September 2008. So at the risk of journalistic indecency, let me recall the news piece that we ran in The Telegraph in July 2008. It cites several leading monetarists.

“The money supply data from the US, Britain, and now Europe, has begun to flash warning signals of a potential crunch. Monetarists are increasingly worried that the entire economic system of the North Atlantic could tip into debt deflation over the next two years if the authorities misjudge the risk,” it began.

That was two months before the sky fell. The monetarists most assuredly saw it coming. So tread carefully.

The soft-landing reasoning which has become so popular lately seems to rest on the assumption that the unprecedented decrease in money supply since March 2022 (a 4.75% reduction in M1, and a 2.49% reduction in M2) merely offsets some of the money created in 2020 and so it should be inconsequential. 

I don't think economies do mental accounting that way, forgiving a declining money supply in exchange for what happened 3 years ago. I also think QT is dollar-for-dollar more consequential than QE because during QT banks must curtail lending as the pool of treasuries available for use as reserves dries up and become more expensive, whereas during QE the overflow can go to non-bank investors. QT on autopilot can also exacerbate a credit crunch in overnight lending markets, whereas QE on autopilot would help.



Finally, I agree with the author that unemployment / initial claims are a lagging indicator of recession, though I hadn't previously looked at how far they can lag. E.g. it wasn't until the 2nd half of 2008 that the unemployment rate debunked prevailing theories about a mild slowdown. Remember this when someone (like Janet Yellen) points to low unemployment as evidence supporting a soft landing future.

MustacheAndaHalf

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #536 on: February 12, 2023, 08:34:54 AM »
Next CPI inflation print out is Feb 14 at 8:30 am EST.
Have you seen any forecasts of 2023 Jan CPI inflation?

"Forecast: 6.2%"
https://www.investing.com/economic-calendar/cpi-733

"Consensus: 6.2%"
(this website's forecast): "6.3%"
https://tradingeconomics.com/united-states/inflation-cpi

(edited to add those forecasts)
« Last Edit: February 12, 2023, 08:40:02 AM by MustacheAndaHalf »

EscapeVelocity2020

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #537 on: February 12, 2023, 09:23:37 PM »
Next CPI inflation print out is Feb 14 at 8:30 am EST.
Have you seen any forecasts of 2023 Jan CPI inflation?

"Forecast: 6.2%"
https://www.investing.com/economic-calendar/cpi-733

"Consensus: 6.2%"
(this website's forecast): "6.3%"
https://tradingeconomics.com/united-states/inflation-cpi

(edited to add those forecasts)

https://www.marketwatch.com/story/inflation-data-rocked-the-u-s-stock-market-in-2022-what-investors-need-to-know-about-tuesdays-reading-e6517631?mod=home-page

Quote
Economists polled by the Wall Street Journal forecast a 0.4% increase in the January CPI, which would slow the year-over-year rate to 6.2% from 6.5% in December. Year-over-year CPI peaked at a roughly 40-year high of 9.1% last summer. Core CPI, which excludes volatile food and energy prices, is expected to rise 0.3% in January, with the year-over-year rate at 5.4% versus 5.7% in December.
...
Jay Hatfield, chief executive at Infrastructure Capital Management, said he is concerned that the core CPI might print hotter than expected.

“What’s been driving inflation down has been the volatile component of used cars. And our data shows used cars inflation is actually going up and not down,” Hatfield said. Meanwhile, the way that the Bureau of Labor Statistics calculates shelter costs tends to lead the number to print higher, Hatfield said.

Louis Navellier, founder and chief investment officer at Navellier & Associates, said he is paying particular attention to owners’ equivalent rent, which is part of the shelter component of CPI. It’s rise accelerated from November to December and the Fed “really does want to see that fall, because that’s the last bit of inflation we need to fall,” Navellier said.

Horizon’s Ladner, on the other hand, said that the Fed itself had signaled that housing inflation would remain sticky, thus it is unlikely to pay much attention to it. Ladner said he is mostly focused on non-housing services-related inflation. “There’s a lot of clarity on what’s happening with goods inflation — it’s obviously coming down,” Ladner said.

Complicating the picture, the January report will see the Bureau of Labor Statistics introduce new weightings for its calculation of the CPI for the coming year. For this year, the bureau has changed its methodology from using consumption data during a two-year period to only one year to weight the CPI components.

It means that the 2023 CPI report will be only based on expenditure data in 2021, when the spending was more heavily weighted toward goods consumption instead of services, according to Richard de Chazal, macro analyst at William Blair.

The January data will in turn also be weighted more towards goods expenditures, which had been moderating, de Chazal wrote in a Friday note.

So yeah, CPI could be up, or could be down, but down because numbers are manipulated, so yay?  Either way, 6.2% still is a long way from 2%.  I like that the trend is down, but markets seem way ahead of themselves.  I don't think things will cool off appreciably, unless inflation really does blow back people's hair Tuesday like the jobs report did...

ChpBstrd

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #538 on: February 13, 2023, 07:31:12 AM »
Next CPI inflation print out is Feb 14 at 8:30 am EST.
Have you seen any forecasts of 2023 Jan CPI inflation?

"Forecast: 6.2%"
https://www.investing.com/economic-calendar/cpi-733

"Consensus: 6.2%"
(this website's forecast): "6.3%"
https://tradingeconomics.com/united-states/inflation-cpi

(edited to add those forecasts)

https://www.marketwatch.com/story/inflation-data-rocked-the-u-s-stock-market-in-2022-what-investors-need-to-know-about-tuesdays-reading-e6517631?mod=home-page

Quote
Economists polled by the Wall Street Journal forecast a 0.4% increase in the January CPI, which would slow the year-over-year rate to 6.2% from 6.5% in December. Year-over-year CPI peaked at a roughly 40-year high of 9.1% last summer. Core CPI, which excludes volatile food and energy prices, is expected to rise 0.3% in January, with the year-over-year rate at 5.4% versus 5.7% in December.
...
Jay Hatfield, chief executive at Infrastructure Capital Management, said he is concerned that the core CPI might print hotter than expected.

“What’s been driving inflation down has been the volatile component of used cars. And our data shows used cars inflation is actually going up and not down,” Hatfield said. Meanwhile, the way that the Bureau of Labor Statistics calculates shelter costs tends to lead the number to print higher, Hatfield said.

Louis Navellier, founder and chief investment officer at Navellier & Associates, said he is paying particular attention to owners’ equivalent rent, which is part of the shelter component of CPI. It’s rise accelerated from November to December and the Fed “really does want to see that fall, because that’s the last bit of inflation we need to fall,” Navellier said.

Horizon’s Ladner, on the other hand, said that the Fed itself had signaled that housing inflation would remain sticky, thus it is unlikely to pay much attention to it. Ladner said he is mostly focused on non-housing services-related inflation. “There’s a lot of clarity on what’s happening with goods inflation — it’s obviously coming down,” Ladner said.

Complicating the picture, the January report will see the Bureau of Labor Statistics introduce new weightings for its calculation of the CPI for the coming year. For this year, the bureau has changed its methodology from using consumption data during a two-year period to only one year to weight the CPI components.

It means that the 2023 CPI report will be only based on expenditure data in 2021, when the spending was more heavily weighted toward goods consumption instead of services, according to Richard de Chazal, macro analyst at William Blair.

The January data will in turn also be weighted more towards goods expenditures, which had been moderating, de Chazal wrote in a Friday note.

So yeah, CPI could be up, or could be down, but down because numbers are manipulated, so yay?  Either way, 6.2% still is a long way from 2%.  I like that the trend is down, but markets seem way ahead of themselves.  I don't think things will cool off appreciably, unless inflation really does blow back people's hair Tuesday like the jobs report did...

OER is about 25% of CPI and is based on…
Quote
… a monthly survey of consumers who own a primary residence. The survey asks how much consumers would pay to rent instead of own their home.

OER is known to be “sticky” because owners don’t tend to pay close attention to short term fluctuations in the price of rentals. The survey is basically asking them to estimate the price of a product they don’t consume and don’t need.

Quote
Homeowners tend to underestimate rent appreciation during expansionary periods and overestimate it during recessionary periods. Research by the Cleveland Federal Reserve suggests the best predictor for OER inflation is recent OER inflation. In other words, OER momentum is a more useful predictor for future OER measures than home price appreciation, vacancy rates, interest rates or unemployment.

Source: https://www.pennmutualam.com/market-insights-news/blogs/chart-of-the-week/2021-02-25-owners-equivalent-rent-and-price-stability

So while OER produces a nice smooth line compared to actual rents (see article for comparison chart) it  causes CPI to be smoother and less reactive to change than it otherwise would be. It forces a sort of momentum factor onto CPI. It’s possible CPI would be falling faster if OER survey respondents had a more accurate read of the rental market, which they are not in!


ChickenStash

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #539 on: February 13, 2023, 08:12:51 AM »

OER is about 25% of CPI and is based on…
Quote
… a monthly survey of consumers who own a primary residence. The survey asks how much consumers would pay to rent instead of own their home.

OER is known to be “sticky” because owners don’t tend to pay close attention to short term fluctuations in the price of rentals. The survey is basically asking them to estimate the price of a product they don’t consume and don’t need.

Quote
Homeowners tend to underestimate rent appreciation during expansionary periods and overestimate it during recessionary periods. Research by the Cleveland Federal Reserve suggests the best predictor for OER inflation is recent OER inflation. In other words, OER momentum is a more useful predictor for future OER measures than home price appreciation, vacancy rates, interest rates or unemployment.

Source: https://www.pennmutualam.com/market-insights-news/blogs/chart-of-the-week/2021-02-25-owners-equivalent-rent-and-price-stability

So while OER produces a nice smooth line compared to actual rents (see article for comparison chart) it  causes CPI to be smoother and less reactive to change than it otherwise would be. It forces a sort of momentum factor onto CPI. It’s possible CPI would be falling faster if OER survey respondents had a more accurate read of the rental market, which they are not in!

This reads like something out of Who's Line is it Anyway... where the rules are made up and the points don't matter.

ChpBstrd

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #540 on: February 13, 2023, 02:51:38 PM »
Here are two new items for deep econ nerds.

1) A researcher found a model more predictive than yield curve inversions or the VIX alone. It involves a roughly circular process on a chart where the yield curve spread is the Y axis and the VIX is the X axis. As the business cycle plays out, the intersect moves from low spreads/low VIX to high spreads/high vix, and back around as illustrated below. There's plenty to criticize here, such as varying business cycle timeframes, shifting axes, shifting pattern shapes, the pattern only coming into view as a 2 year moving average, and the resemblance to "technical analysis" and yet this is still possibly the most interesting concept since Cambell Harvey's yield curve research in the 1980s.

2) It was pointed out to me that during most recessions, the rate of change in the number of people working full time decreases to below the rate of change in the number of people working part time. This is an inversion of the normal situation, where FT employment growth exceeds PT employment growth. The trend seems to start up to a couple of years before the recession, and the FT/PT inversion point has always previous occurred sometime during the recession. One might predict that a recession will be occurring at time X if that is the future intersection point of the trend. Only thing is... the line already intersected in January 2023!

Only one other time in the history of the two series has this occurred when a recession was not in progress. The recent jobs numbers are evidence against the idea that we're currently in recession, but not evidence a recession isn't close. In past recessions, the FT/PT inversion occurred only shortly after the start of the NBER recession. In the 1969 recession, inversion occurred 2 months after the recession started. In the 1980, 1981, and 1990 recessions, inversion was 3 months after the start. In 2001, the inversion was only 1 month after the recession started. One false alarm appears to have occurred during 1994, but that episode looks a lot like a statistical issue occurring in that one calendar year. So in summary, this indicator is suggesting we're in the neighborhood of a recession start date.


https://fred.stlouisfed.org/series/LNS12500000#0

Mr. Green

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #541 on: February 14, 2023, 06:42:23 AM »
January CPI-U came in at 0.5%. 12-month CPI tagged at 6.4%. It's just one month but the decrease in inflation appears to be leveling. Just an off month or are we sticky in the 6s? If we're sticky then the Fed does indeed have a ways to go.

A personal note, food at home continues to have a year-over-year inflation rate over 10%. I think this is one of the most damaging parts of what is happening right now. Grocery store prices continue to increase at eye-watering rates and I fully expect these to go up and never come down. This is going to create real hardship for people in the lower class over the next 5-10 years and the financial effect becomes cumulative.

blue_green_sparks

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #542 on: February 14, 2023, 07:31:41 AM »
During the State of the Union as the touting of the good unemployment numbers was underway, I was thinking about others in the government who are seeking to kill those very numbers. Our food costs (and other supplies) are indeed still rising; I can see that in our expense records. I have been able to offset the costs with short term fixed. I have a 3yr annuity maturing in a few weeks and the renew offer is at 5.5%. Not too shabby.

ChpBstrd

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #543 on: February 14, 2023, 10:04:13 AM »
The CME FedWatch tool is now predicting a peak FFR upper range of 5.5%, to occur this summer. The terminal rate goalposts are still moving!

Again, never in modern history has the Fed raised rates by anywhere near this much and not caused a recession. We should think of recession odds as near 100%, given the rate hikes and all the very clear pre-recession warning signals and the nowhere-to-go-but-up unemployment rate. 

Most traders are still expecting a rate cut by November or December. Maybe that's why the 10/2 yield curve has continued falling to -0.80. I think for that rate cut to happen this year, we'd have to enter recession by the 2nd quarter. Otherwise the ghost of Arthur Burns and his premature rate cuts will haunt Jerome Powell. Any later than that and the Fed will not have enough data in hand to possibly make a reversal decision this year. Also, rates will only fall this year if the recession is severe - maybe precipitated by some disaster like an escalation of the Ukraine war, another real estate meltdown, or a series of financial institutions failing.

Paper Chaser

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #544 on: February 14, 2023, 10:13:53 AM »
If I'm reading the table correctly, it appears the majority of the categories that make up the CPI calculation saw increased rate of inflation from December 2022 to January 2023:

https://www.bls.gov/news.release/cpi.nr0.htm

The only significant declines noted were new vehicles and medical care services. Energy saw significant increases while clothing, and medical supplies also climbed measurably. Housing remains essentially flat to slightly elevated from Jun of 2022. Considering those numbers, and the current job market, I think the FED is very likely to take rates higher than was expected late in 2022. The primary question for me is whether they do it in large chunks or small bites. Honestly, a .5 increase at the next meeting wouldn't shock me given most recent data.

Paper Chaser

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #545 on: February 14, 2023, 10:17:25 AM »
Charts!




Also, total inflation is now up 16.2% this decade:
« Last Edit: February 14, 2023, 10:26:24 AM by Paper Chaser »

Paper Chaser

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #546 on: February 14, 2023, 05:07:46 PM »
Is 'FUT' futures?

ChpBstrd

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #547 on: February 15, 2023, 03:05:56 PM »
Nice charts @Paper Chaser. The visualization really helps! I wonder if we are in a loop with the shelter component, in which rising interest rates cause shelter prices to rise, which justifies higher rates to reduce the inflation. It seems house prices are not falling in a way that would be justified by higher rates, because home buyers now expect rates to be cut in the future. If mortgage rates go back down to 3-4% in a couple of years, home buyers can refinance and do OK. If not... bad news.

Today a few anti-recessionary bits of information were posted:

1) The National Financial Conditions Index is continuing to improve. We're now not even in recession territory per this metric.

2) Retail Sales went up in January after declining in Nov. and Dec.

3) Business Inventories continued to rise modestly, resuming their pre-pandemic trendline.

4) The Retail Inventories to Sales Ratio suggests that retailers are keeping 1.26 months worth of sales in inventory. This is increasing, but still lower than the 1.45 range that was typical in 2019. It seems retailers are being cautious about building up inventory prior to a potential recession.

All this suggests the 4.5% FFR upper limit was insufficient to slow the economy in January, when CPI grew half a percent. But then what happened in November and December, when it seemed the economy was grinding to a halt? We can attribute some of this to statistical noise, but maybe January's numbers are a reminder that economic data should always be viewed as a trend. No outcomes are off the table yet!

Tomorrow we get weekly initial claims and residential construction numbers.
« Last Edit: February 16, 2023, 08:32:49 AM by ChpBstrd »

Mr. Green

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #548 on: February 15, 2023, 06:57:22 PM »
We're in this weird place where the health of the real estate market has become somewhat of a self-fulfilling prophecy. Home builders saw record numbers of contract cancellations as mortgage rates zoomed from the 3% range last spring to almost 7% in the fall. Then interest rates came down as data started to indicate that inflation was falling and investors cheered the possibility that a disaster scenario wouldn't happen. As mortgage rates came down into the fives I think a number of buyers came back to the table thinking this might be about as good as it gets for awhile. I know there was definitely a noticeable uptick of activity where we live. I would expect the numbers release tomorrow to reflect that period of increased activity. However the 10-year treasury has once again pushed close to 4% and mortgage rates are well above six again. If investors once again fear that higher interest rates will be required to tame inflation it may drive the 10-year treasury yield to new highs and in turn cause mortgage rates to rise back to deal stopping levels.
« Last Edit: February 15, 2023, 07:06:21 PM by Mr. Green »

Paper Chaser

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Re: Inflation & Interest Rates: share your data sources, models, and assumptions
« Reply #549 on: February 16, 2023, 05:57:40 AM »
I know this isn't a housing thread, but as 'shelter' makes up such a large part of CPI calculation, and recent comments have focused on housing I think this is appropriate:


Even with the recent uptick, mortgage applications were down 42% YoY and remain at levels similar to what we saw from 2010-2014. Demand has collapsed as rates have cratered affordability. The only thing keeping prices up is limited supply.

Housing decisions are driven by monthly affordability. And affordability is driven by interest rate and income. Incomes went up, and rates went down at the same time, so homes became a bit more affordable in the last couple of months compared to last fall. With all of the liquidity out there, that slight improvement seems to have been enough to motivate some buyers even though many (most?) remain on the sidelines.


« Last Edit: February 16, 2023, 05:59:25 AM by Paper Chaser »