You may know I can often be found flying when I’m not on the ground pondering the markets. It’s a fun hobby and one I take pretty seriously. I’m going to draw on this as we answer the headline question, “Is any landing a good landing?” If you’ve ever flown with me, you know that’s not the case. Not every landing is a good landing and not any landing you can walk away from is a good landing, despite this rather funny quip from famed pilot, Chuck Yeager.
In order to carry passengers, pilots must have three takeoffs and landings in a 90-day period. Many pilots I know joke, “If you bounce on the landing does that count as two?” Uh, no! In fact, maybe you should keep trying until you do it right.
As much as I would like to get away from pilot talk, today I would like to discuss the different “landings” the economy could have and what that might mean in the current economic environment. Landings have become the preferred analogy as we (the collective, not just MPCA) look ahead at the economy.
The different landings are described as ‘hard landing’, ‘soft landing’, and ‘no landing.’
The backdrop for the economy right now is low unemployment, high inflation, and currently subpar growth. As we have said so many times in the past, the FED can only pull one lever to try and change any of these conditions. That is interest rates/money supply.
Raising rates and making money more difficult to get will slow down the economy, and lower rates and easier money will speed up the economy. Don’t forget the FED has two mandates: Full employment and stable prices.
Full employment used to be considered 5% when I went to business school (when we used stone tablets). Today, full employment could be less than that. The key consideration is when is there too small a pool of candidates for jobs that it causes too much wage inflation? That’s a fine line that no one really knows.
So, given that we are at (or past) full employment and inflation is high but coming down, the trick for the FED is to figure out how tight monetary conditions need to be in order to bring “stable prices” (inflation) down to their target of 2%? We’ve talked about the arbitrary 2% inflation target. That’s what they are targeting for the moment, let’s see if they change their tune down the road. It’s entirely possible.
The current FED “dot plot”, where the different FOMC participants expect interest rates to be in the future, looks like this (remember, you can click on any image to see it larger!):
You can see that the majority of the governors think that rates will peak in the 5.25% to 5.5% range. Today the current FED funds rate is 4.5% to 4.75%, so we have about 3/4 of a point to go. But let’s look at the different inflation reports. First is the CPI (Consumer Price Index).
Still hanging out in the mid-6% range and didn’t go down last month like everyone hoped for. How about the PPI (Producer Price Index), sometimes called the Wholesale Index.
You can see that PPI is also down significantly from its highs in March of last year. Now to the inflation report that the FED likes most – the PCE price deflator.
The “core PCE” hasn’t come down much since last April. So, we have to ask, is the FED raising rates enough to slow inflation? That question brings us back to the landing scenarios.
First let’s look at the ‘soft landing’ scenario. That would be where the economy doesn’t go into a recession, but instead just a prolonged period of low growth. My guess would be that unemployment goes up a little but may not be enough. While this might be the preferred outcome, I’m not sure we get inflation down enough. This would be the “perfect landing” in an airplane, you know the one that nobody feels (I wish that were the landing outcomes all the time).
The second is the ‘hard landing’ scenario. Unemployment goes up (probably close to 5%), demand goes down significantly, and inflation comes down to the 2% range. While that is the FED goal, it also happens to be the most painful outcome for most people. A couple million people are laid off and all the debt that has been accumulated over the last few years could add stress to the system.
Finally, is the ‘no landing’ scenario that is suddenly gaining some traction. Honestly, before about a month ago I had never heard of that. In the world of flying, that’s called STILL FLYING! So how do we get inflation to come down while EVERYONE IS EMPLOYED and demand is very robust? Perhaps its possible if all of this inflation was truly just the result of supply-chain issues (and those issues are resolvable in the near-term), but I just don’t see that as the case. Inflation can’t possibly come down to the FED’s target of 2%, in my opinion. Maybe you say they will adjust their target to 3%-4%? Ok, maybe I could buy that.
But assuming demand stays robust, how do we explain the amount of debt that has been accumulated since COVID?
All this while mortgage rates are 7%(ish), credit card interest rates are north of 18% and car loans rates are 6-7% for those with good credit. Doing the math, I don’t see how ‘no-landing’ is remotely possible. I wish it were.
So, while I try to look through my rose-colored glasses, I find that we still have some work to be done in the wake of the massive fiscal and monetary stimulus during COVID. Unfortunately we will expect more layoffs in the next six months, but keep in mind that once the “market” discounts a recession, that’s the time to buy. Until then, patience is a virtue.
Have a great week. If you have any questions or want to talk through something, let’s talk.