No one is talking about a soft landing anymore

Posted by David Nelson, CFA on October 3, 2022 in Investment Management | Leave a comment

By David Nelson, CFA 

Let’s start the conversation by agreeing we need to cure the cancer of inflation. An unchecked rise in prices spinning out of control helps no one and risks pushing the U.S. economy further into crisis.

However, every oncologist knows that administering chemotherapy at a pace beyond what the body can absorb risks unintended consequences, even death.

The Federal Reserve under the command of Chairman Powell continues to drive Fed policy like a bumper car. Bouncing from one crisis to the next in part trying to make up for poor decisions the Fed will likely drive the economy right off the road. 

No one is talking about a soft landing anymore. David Sacks general partner of Craft Ventures recently said; a better question might be is anyone driving the plane? The Fed says they are data dependent, but previous actions prove otherwise.

A year ago, with inflation raging they continued to keep their foot on the accelerator creating insane moves in asset prices including commodities, stocks, bonds, houses and just about every item on the planet that had a price tag. Even after admitting in November last year, it was time to retire the word “transitory”, the Fed continued to buy bonds all the way until March of this year.

Markets and data move in real time, yet the Fed seems overly reliant on data sets that are at best backward-looking ignoring tools made available in the internet age.

Big Data drives the world. The importance of data, especially in real time, is understood by the world’s most successful technology companies. You search for a new bed on the internet and minutes later you’re getting ads on your Facebook feed for beds and accessories.

According to the BLS (Bureau of Labor Statistics) the CPI dates back to 1912. The BLS recognizes the need to move to alternative data sets but by definition government agencies move at a glacial pace, and I suspect today aren’t keeping up with the changing face of the American consumer. In a 194 page report sponsored by the BLS The National Academies of Science Engineering and Medicine explores methods to advance the process.  

Scanner data, and web scraping techniques are all being used but need to be updated to modern techniques used throughout the industrial complex. Real time credit card data, shifting your focus to those at the bottom of the income ladder where inflation hits hardest should take on added importance in models the Fed currently uses. 

If Facebook can figure out what you want to buy in real time, I have to believe the Federal Reserve with its infinite resources can modernize and move beyond what increasingly looks like a keep hiking until something breaks mindset. Even with new tools the human element seems to continually fail.

Unintended Consequences

The elephant in the room beyond a stock market pointing to recession is the U.S. Dollar. It helps the inflation effort here but like it or not we still live in a connected world. The pain being felt especially in emerging markets should be a concern for us here.

Black Swans seem to have a way of popping up where you least expect them. Admittedly, in 1997 I was new to the world of running money and my skills weren’t fully developed but I don’t remember hearing any warnings about the approaching Asian contagion.

Asian Financial Crisis

In July of that year Thailand unpegged its currency to the U.S. dollar triggering the Asian Financial Crisis. While the events were taking place half a world away it didn’t take long for the storm to hit the trading desks at Lehman and every other firm on the street.

Between July and November 1998 many stocks in the financial sector went down more than 40% in just a few weeks.

Rising Voices of Concern at the Fed

The financial press is starting to report some rising concern within the Federal Reserve. The need to keep rates higher for longer is supported by all but the pace at which we get there may be a subject for debate.

Vice Chair Brainard on Friday said the Fed will need to be restrictive for some time. That isn’t news as all members have been in lock step with their public comments. However, she added a note of caution on how fast they need to go. In the same Bloomberg article, she cautioned that it will take time for the full extent of tightening to bite down broadly across the economy, another way of arguing for some patience starting now.

The Fed also has to be cognizant of the fact that they cannot do this job alone. It does no good for the Fed to continue to drain liquidity from the system while the administration pours it back in. Controversial programs like student loan debt relief only add to the problem. I get that it’s an election year and $10,000 to buy a vote may seem cheap but programs like this just pour fuel on the fire.

There has to be at least some thought given to the concept that broken supply chains and logistical challenges around the world along with the secular struggle of deglobalization are contributing factors to inflation. The above are all beyond the Fed’s skill set to address.

Pension Pain

What will prove more damaging than a course correction of Fed policy is an abrupt about face like the one forced on the Bank of England by pension plans. Cratering UK – 30 Year bonds pushed yields up to close to 5% forcing the BOE to step in with a quantitative easing like move to shore up the market.

Coming into 2022 confidence in our Federal Reserve was thin. It was well understood that they were behind the curve and would have to play catch up. Chairman Powell needs to balance his desire to regain that respect with policy that can cure the cancer without killing the patient.