29 Jul The Fed Rate Hike & GDP: A New Great Recession?
“This week’s Fed Rate Hike and negative GDP report provide recession grist for would-be oracles, but don’t bet-the-farm on alleged experts’ conjectures. No one can predict the future.” – The Lonely Realist
Those who assert their ability to predict the future are optimistically representing their guesses as likely realities. That’s not surprising. Predicting the future, after all, is a game for charlatans and soothsayers, whether they be pundits or mere frauds. Their crystal-ball gazing goal is promotional. Their predictions are conjectural, based on selected assumptions, cherry-picked facts and subjective theses. Given the parlous state of America’s economy, as America’s negative -2.5% GDP growth these past 6 months confirms, today’s most popular prophets are those who blame it all on the awful, rotten, appalling, misbegotten actions taken by the Federal Reserve. They have adapted their forecasts for future turmoil accordingly. Pundits who purport to explain the economic forces that have pulled-and-pushed America’s economy since the 2008-09 Global Financial Crisis lack the necessary historical perspective (the need for which was emphasized by Chinese Premier Zhou Enlai’s 1972 response to the question of what the impact had been of the 1789 French Revolution: “It’s too early to say”). Who today after all can conclude that an action taken by the Fed in 2012 was the cause of a bad-outcome in 2022 or that a different action would have caused a better one? In the end, even the best prognosticators with the most time, the greatest perspective and unlimited data can only speculate as to cause and effect. Today’s economic soothsayers instead are playing the blame game, accusing the Fed of having missed obvious “what ifs” and “what-might-have-beens.” Things of course could be better. They always can be, which is what the benefit of 20-20 hindsight provides.
There is no disagreement that America today is experiencing undesirable inflation, that GDP growth over the past decade has been anemic, that inequality has swelled, or that America’s economy is being threatened with recession. Maintaining balance in America’s multi-trillion dollar economy is no easy task. Responsibility for doing so is a political commentary among Congress, the President and the Federal Reserve. That fiscal responsibility has risks (which both Congress and successive Presidents have largely ignored). And, yet, the current state of the economy has led soothsayers to cry that “Today’s economic problems are all the Fed’s fault” (while political partisans place the blame on the Bush2 and/or Obama and/or Trump and/or Biden Administrations (all of which, as TLR has noted, share the blame for today’s economic problems).
A recent article by Mohamed El-Erian (the chief economic adviser for Allianz) is illustrative. In it, El-Erian berates the Fed for its lack of clarity in informing and influencing the financial markets and for consistently being a follower of market actions rather than a leader (i.e., “blame it all on the Fed”). He expresses concern that the Fed’s all-too-apparent weaknesses could lead to “even more catastrophic policy mistakes” and is particularly concerned that the Fed will adopt a “stop-and-go policy” of alternately tightening economic policy (Quantitative Tightening (QT)) and easing (via Quantitative Easing (QE)). Although El-Erian is correct that we are in the midst of an extremely hazardous economic period in which missteps by the Fed could compound the problems, placing the responsibility solely on the Fed misses the mark. All government actors share the burden for failing to address economic risks and, if they had the resolve, they together could take action to mitigate the downside. The fact is, however, that the number and nature of black swan events over the past 2+ years have made it impossible for any actor to have reacted ideally and, furthermore, have created limited alternatives going forward. Given these realities, Nouriel Roubini (who the New York Times has labeled a permabear) has sounded an even louder alarm, saying that “There are many reasons why we are going to have a severe recession and a severe debt and financial crisis,” much of which he believes is based on poorly-conceived Fed policy. His bearish forecast echoes the Delphic Oracle’s warning in the June 4th TLR: “The sad fact is that a recession already has begun…. Q2 is likely to see further GDP weakness (following Q1’s negative growth of [-1.6%]). The economy will weaken measurably as Summer begins. That’s when the stock market again will take notice … and crack.…”
Is the Fed truly to blame? How badly has the Fed actually performed?
Cassandra believes it has performed quite well, asserting in her most recent TLR interview that “Jay Powell and America’s Federal Reserve have proven themselves most capable economic captains. The Fed’s creative policies avoided economic depression during the Global Financial Crisis and the Fed thereafter successfully navigated the world economy through a 12-year period of consistent growth. Those are extraordinary accomplishments that few thought possible in 2009. And the Fed did so once again by avoiding economic calamity during the global COVID pandemic. The Fed has utilized a flexible set of financial tools, tested them out, and honed them to a fine point. It now is in the optimal position to once again apply them to fine-tune America’s economy and achieve a soft landing.”
Cassandra’s praise for the Fed’s prior actions has validity, yet what does that portend for the future?
Despite the hype, the Fed has only limited ability to positively impact America’s economy. There are far too many inputs that require Legislative and Executive Branch action. Moreover, a number of unforeseeable occurrences have been significant drivers of today’s economic difficulties. The COVID pandemic and its impact on employment and economic dislocation, the Ukraine War, China’s zero-COVID policy, knotted supply chains, the end of generous government stimuli, and successive American governments’ application of Modern Monetary Theory have serially and cumulatively battered the economy, forcing the Fed to amend its policies. Whether the Fed’s policies would have been fully successful in their absence is unknowable (a further “what if”). Some of its actions clearly missed the mark. Yet the good news is that the occurrences that caused the Fed to alter course have begun to sort themselves out (as Jay Powell’s post-Fed Rate Cut announcement this week indicated). Supply chains are untangling. Oil and gas prices are decreasing (a trend that hopefully will continue). Shipping bottlenecks have been easing and supplies of computer chips, lumber, baby formula, etc., are increasing. Ukraine’s ports have reopened, easing the strain on food prices. Labor markets have loosened while hiring is continuing apace (with America’s unemployment rate now at only 3.6%). And recent data suggests that inflation may have topped out. With the Fed providing consistent QT execution, confidence also has been returning to the financial markets. The S&P500 in July broke its longest technical streak of closes below its 50-day moving average since 2009. Valuations have been improving and the S&P500 this month saw its broadest advance since 2018 and its best month since 2020. Capital spending by S&P500 companies is rapidly increasing, rising in Q1 by 20%. The direction of the markets and their breadth therefore are consistent with renewed economic strength. Although these admittedly could be signs of a bear market rally (which this week’s announced Q2 GDP decline of -0.9% suggests), they also could be indications that the QE policies being pursued by the Fed indeed are “fine-tuning America’s economy so that the Fed will achieve a soft landing.”
With that said, there are relatively few who share Cassandra’s optimism. The smartest economic professionals are in agreement with Mohamed El-Erian and Nouriel Rubini that more difficult economic times lie ahead (and that they will variously result in out-of-control inflation (rapidly-growing debt and more than a decade of money-printing plus artificially-low interest rates is a textbook formula for hyperinflation), stagflation, out-of-control onshoring, Dollar and/or debt crises, and/or recession). Projections for America’s economic growth after all have been ratcheting down over the past several months. (And, yet, this massive doom-and-gloom consensus might lead a contrarian to credit Cassandra’s predictions.)
The one clear conclusion is that the predictions being proffered are guesses. While TLR endorses the view that the Fed avoided economic calamity by successfully guiding America’s economy through truly turbulent times, risks now abound. They include ongoing policy errors, renewed food, energy and parts shortages, and black swan events, all of which make navigating the next several months and years an extraordinarily challenging task.
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Finally (from a good friend)