We now have a hot jobs report, a hot CPI report, and a hot retail report out of the US. This is scintillating stuff from Steven Blitz at TS Lombard.
So much for immaculate disinflation. January CPI data make clear that inflation is not dropping to 2% without a recession raising unemployment above 4.5% and this underscores my long-held view that the Fed erred by downshifting hikes. Money is not expensive on a pre-2008 basis and slowing the hikes to 25BP eased financial conditions, thereby reducing the Fed’s squeeze on an economy powered by asset inflation. A mild, mid-year recession is still my base case, believing that higher carry costs, lower equity prices, and inversion of real yields are still disruptive enough in total to weaken high skill employment and wages. In turn, spending slows and kicks off a small inventory cycle. The NY Fed’s latest Survey of Consumer Expectations reveals that this dynamic is beginning.
If there is no recession, as I have noted before, the Fed will rue its choice. The Fed is operating from its 2004-07 playbook – targeting the funds rate to reach some high real level using steady 25BP hikes, then keeping high real rates steady for an extended period while waiting for unemployment to rise to cut rapidly (Chart 1). This is not the same economy. Households are not overleveraged, let alone overleveraged on housing, the recession trigger resides with the asset side of household and corporate balance sheets. Further, there is today a structural labor supply/demand imbalance sustaining high wage growth that has the funds rate far from where it was in 2006-07, relatively speaking. Scheduling 25BP rate hikes every six weeks on into infinity is a gradualism that can morph into “perpetualism” . The slow pace can allow inflation to accelerate anew, underwritten by an upturn in credit creation.
