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CNBC: Ron Insana says the Fed is defying logic by trying to create a recession

Below is an excellent article highlighting the alternative view of what the federal reserve should be doing today.  Though the article makes good points, the Federal Reserve does have to move off of negative real rates and begin to normalize monetary policy.  Federal reserve forward guidance is to normalize monetary policy, not to create a recession.

I agree with the author’s view that the Federal Reserve will not be able to raise rates as high as the futures market indicates.

Given this view, the steepening 10 yr yield curve will begin to flatten in the second half of this year as the markets look forward to 2023 and growth rate expectations begin to slow.

Assuming we don’t hit a recession, but normalize economic activity as forecasted, a flattening 10 year yield curve will allow high revenue strong cashflow (RME factors) companies to recover and continue to outperform as they did in the 2017 through 2019 time period.

So far our internal momentum models support the no recession thesis:

1) S&P 500 earnings continuing to beat, guidance has bottomed and now getting revised up – full year growth of 5 to 6%.

2) Consumer activity and re-opening acceleration looks solid, wage gains have helped consumers overcome blunt impact of inflation at the macro level. As job growth continues  – more jobs equals more spending.

3) Housing starts and sales remain on trend.

4) All of our economic leading indicator models support no recession in 2023.

5) SVCP US accelerometer gives a positive signal.

6) Early signs of an inflation peak have started and China economic reopening will be a tail wind for stocks during the second half of 2022.

7) The trigger for stocks bottoming will be the 10 year yield peaking – transition to flattening sometime in the backend of 2023, hard to predict but look at this as an event driven recovery.

 

Ron Insana says the Fed is defying logic by trying to create a recession

Volcker or Vulcan?

Whom should the Fed emulate today?

With a consistent chorus of economists, ex-policymakers and businesspeople calling on Federal Reserve Chairman Jerome Powell to crush inflation now, they are panicking as if today’s inflation is the exact twin of what plagued the U.S. economy some 40-plus years ago.

The comparison is, in the words of a well-known Vulcan, illogical.

Powell nearly admitted as much on Wednesday when he said some of the inflation currently being generated, at home and abroad, is well beyond the Fed’s control.

I have argued that almost all of it is and that aggressively tightening credit conditions, by both raising interest rates and launching Quantitative Tightening (QT), the Fed is overreacting to the long-term risk posed by short-term effects.

I’ve also argued that today’s inflation is much more like a post-war phenomenon than a series of adverse shocks that hit the economy from the late 1960s until the early 1980s.

At that juncture, then-Fed Chairman Paul Volcker enacted record-setting rate hikes that drove short rates above 20% and long rates above 14%. That was a logical response to the better than decade long build-up of inflationary pressures that was a multi-factor phenomenon.

In my Volcker vs. Vulcan scenario, a more sober assessment of today’s inflation would attempt to measure risk versus reward and causation versus coincidence.

The enduring nature of the pandemic, now largely affecting China’s economy and further disrupting global supply chains far beyond what was once a reasonably expected, is at the very root of the elevated prices we see today. This is a domestic Chinese policy issue first and a global economic and foreign policy question second.

In addition, the Russian invasion of Ukraine has unexpectedly, and massively, reduced the output of energy and food supplies globally, leading to yet another supply shock resulting in higher prices abroad and here at home.

That won’t end until this war is over and it won’t be solved by any central bank.

It’s been noted, of late, that American grocery bills are going up for meat and poultry as well.

It’s not just higher feed prices, or a lack of fertilizer, pushing up the prices of meat and vegetables — an outbreak of bird flu is reducing the supply of chickens, making even the most affordable of meat substitutes less costly than it was only a few months ago.

We know how painful inflation is and we are working hard on fixing it, says Powell
And as for wage inflation, by the Fed’s own admission the cost of labor is rising only in part because of increased demand for consumer goods and services.

Chair Powell noted that there are currently 11.5 million open jobs in the U.S., nearly double the number of unemployed workers — another shortage due, at least in part, to pandemic-related issues.

Against that backdrop, it now appears the Fed is, however, hell-bent on pushing the economy to the brink of recession and pushing the unemployment rate up to relieve inflationary pressures that, to me, remain transient, in the broadest of terms.

And I don’t mean that those pressures will abate in a matter of months, but as in prior post-war periods, inflation falls as supply returns, even against a backdrop of rising demand.

It is entirely illogical to believe that aggressive tightening will shorten the lockdowns in China, end the war in Ukraine, produce over four million American workers out of thin air, or even cure our chickens before they hatch.

I don’t know of anyone, outside of St. Louis Fed President James Bullard who seriously believed the Fed would raise rates by three-quarters of a percent in this tightening cycle. As we saw on Thursday, the belief that there was relief was a fatally flawed construct.

While logic dictates that the Fed gradually normalize rates and, one day, reduce size of its balance sheet, it’s becoming extremely clear that the Fed intends to create a recession, not avoid one.

If forced to choose between Volcker’s approach to today’s inflation, or a Vulcan’s, I’ll go with Mr. Spock every time.

Volcker was justified in driving the economy into a deep downturn to conquer imbedded inflation in 1980, even though those actions led to several adverse events, like the Latin American debt crisis, that ultimately forced him to reverse course and ease.

Logic dictates the Fed not try that again, not today.

The economy is already beginning to slow. The dollar is rising rapidly and there will be a price to pay for misidentifying the root cause of today’s economic problems.

The very notion of engineering a recession to reduce normalized demand in order to meet drastically reduced supply causes me to raise an eyebrow and insist that “This is highly illogical, Captain.”

May 6, 2022