Image Credit: Brenda Gottsabend

Labor Market Statistics are Pointing to Lower Wage Inflation

The job market may be returning to normalcy; this is a good sign for lower inflation. The
JOLTS report, which is released by The Labor Department, is similar to a supply chain measure for how adequate the economy’s labor and jobs match up. It tracks monthly changes in job openings and job offer rates on hiring and also quits. Overall, the movement toward what was considered normal and even desirable before the pandemic has accelerated. JOLTS is an acronym for Job Openings and Labor Turnover Survey.

The Numbers

Job openings fell to 10.7 million from 11.3 million in June, according to the data released Tuesday (August 2). The median estimate from economists was 11 million, which means jobs fell short of expectations. It was the largest one-month drop since the pandemic. This gives hope that shortages of labor have decreased.

Largest among the drop are positions in retail. Retailers accounted for more than half of the decline in openings. The sector shed 343,000 openings in June. Wholesalers followed with the next largest drop of 82,000 openings. Public education was third, with openings reduced to 62,000.

The industry seeing the most gains in job listings was the finance and insurance category; this sector added 31,000 openings. And while positions in public education were down, positions in educational services increased by 22,000 openings.

Source: St.
Louis Federal Reserve

The number of unemployed Americans per job opening climbed to 0.6 in June from 0.5. This added to signs that the labor market is normalizing. However, 0.6 people for every 1.0 position is still a challenging mismatch for employers. However, it is the first move toward having at ample people looking, even if they may not be an adequate fit for each role. The JOLTS report had a three-month streak of record-low workers-per-openings ratios. This is good for employers and helps taper wage pressures.

Source: US
Bureau of Labor Statistics

There is still plenty of room for further movement toward normalcy. Labor force participation, that is,  the percentage of Americans either working or actively seeking work, dropped in June to 62.2%. Pre-pandemic, the participation rate was 63.4%.

Resignations or quits data also point to the labor market’s imbalance moving towards normal. The total quits in June dropped to 4.2 million from 4.3 million. This is the lowest level since October. Quits have now fallen for three straight months straight after breaking records last year.

Take Away

When labor markets are not tight, wage earners are less likely to require higher wages to stay. One of the factors contributing to the year-long inflation spike in the U.S. is a shortage of labor. The lower number of job openings and reduced quit rates now suggest the supply and demand of workers may be moving toward better alignment.

A healthy economy requires willing and suitable workers and adequate positions for those workers. June was a good sign that this is beginning to occur.

Paul Hoffman

Managing Editor, Channelchek

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The Fed Chairman is Less Likely to Box Himself in With Specific Promises

It might surprise investors born after 1990 that back when 69-year-old Jerome Powell was a young man working for an investment bank, the Fed was very secretive. There was no forward guidance announced, and rate moves were never made immediately after FOMC meetings. Instead, the Fed changed policy secretly on random Fridays. Any adjustments to Fed Funds levels were not made certain to the public until the minutes were released over a month later. The markets were instead left to figure out what the Fed may or may not be doing.

The covert Fed slowly became more open under pressure from Congress toward the end of Greenspan’s 18 years. His last term ended in early 2006. He was followed by Bernanke, who, as part of the financial crisis of 2008, moved toward an even more overt Fed, signaling what to expect years out so that markets would be calmed. Yellen followed Bernanke and continued the policies of setting longer-term expectations.

Powell’s first term caused another leap toward more openly showing the Fed’s playbook to the world. The Fed made sure there were no surprises and worked to calm fears. After all, he was Fed chair during the pandemic, it became important for the U.S. central bank to show it had a plan; this helped to maintain confidence in economies worldwide.

Today Powell has continued his pandemic era guidance up until the last interest rate move in June, where he moved more aggressively than previously stated he would. Otherwise, he has, well in advance, let markets know when and by how much rates are going to move. In June, he had previously guided a 50bp tightening. Just prior to the meeting, stronger economic numbers were released; this prompted the FOMC to move by more than the initial telegraphed guidance.

Since it began its current round of interest-rate hikes this year, the U.S. Federal Reserve has aimed to let investors know ahead of time, not just where rates are heading but exactly how big a move to expect each time. It also more aggressively reduced its previously announced purchase of securities (tapering) as it became clearer to Fed governors that inflation was more persistent than transitory.

Fed Chair Powell wants the markets to know that he reserves the right to change plans as conditions change. He did this by moving 75bp in June and by changing the tapering strategy. Conditions are now too uncertain to be locked into 90-day-old promises. He isn’t likely to abandon telegraphing expectations, but he doesn’t want to jolt the market if he and other voting members of the FOMC adjust their thinking last minute. This gives them more flexibility.

The Fed’s ability to be more nimble and pivot should create confidence within the markets. During the 2008 financial crisis, what the markets needed to hear was rates would be held low for a long time; this way, capital could flow with increased confidence. Now the confidence would seem to come from the comfort that the Fed will do what it takes even if it shifts its plans unannounced and more quickly.

“It’s a very difficult environment to try to give forward guidance 60, 90 days in advance,” Powell said during a press conference on May 4^th. “There are just so many things that can happen in the economy and around the world. So, you know, we’re leaving ourselves room to look at the data and make a decision as we get there.”

Take Away

As the head of the world’s most powerful central bank, battling record inflation, Powell’s primary duty is to get it right; estimating what the months ahead will bring is too difficult, and tying the Fed’s hands with pre-announced moves could interfere with the needed precision to achieve an economic soft landing.

On Wednesday, July 27^th, the FOMC ends a two-day meeting at which they are expected to agree on a 0.75 percentage point increase. It is likely that the statement afterward will again put parameters around what to expect after the September 20-21 meeting. But that meeting is two months away, so the wording may be less exacting than we have become accustomed to.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20220504.pdf

https://www.reuters.com/markets/us/fed-chair-powell-is-not-done-telling-markets-where-rates-will-go-2022-07-26/

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What is Meant by Fed Quantitative Tightening?

Quantitative tightening (QT) is implemented when quantitative easing (QE) has been successful in inducing economic activity. QE is when the Federal Reserve buys fixed income securities, usually treasury notes and securitized mortgage bonds. Simply put, QT is the unwinding of these purchases.

As the U.S. Federal Reserve believes financial conditions have improved and that keeping additional money in the economy would do more harm than good, they begin to work toward “normalizing monetary policy.” This normalizing or tightening policy is accomplished by not replacing all maturing securities with new purchases each month. A maturity pays the owner (the Fed), so not rolling this money into new purchases has the effect of reducing the money the fed added to the economy during the QE cycle.

Before QT the Fed usually has begun forewarning that they would directly be impacting short-term rates through a higher targeted overnight rate.

To orchestrate QT, while trying not to over shock a recovered economy, the Fed creates a schedule to allow maturities and fewer purchases to equate to the amount in its plan.

For example, the Fed may allow $30 million in treasury notes and $15 million in mortgage-backed securities to mature in each of the following three months without repurchasing this amount. Over the next three months, the QT plan may then call for increasing these amounts. Each time the fed changes monetary policy, they know the change in money in the economy takes time to play out and work. Even though they have a plan, that plan can be adjusted if something isn’t working.

As the bonds mature, the excess money supply that was created when they were purchased from the Fed’s account is taken out of circulation. With less money in consumers’ hands and interest rates on the rise, spending starts to decrease. As the law of supply and demand suggests, a decrease in consumer demand leads to slowing asset price growth (inflation).

If the Fed moves too quickly with its quantitative tightening plan, it could stifle demand too quickly for the supply side to adjusted which could cause an economic recession (negative growth).

Quantitative tightening is typically implemented when the economy has grown too fast for its own good due to a mix of low-interest rates and excessive asset purchases from the Fed. During these times, inflation becomes a concern. One of the US Federal Reserve’s mandates is to maintain stable prices. 

The Federal Reserve is said to hold the securities used for quantitative tightening on its balance sheet. So if you hear the Fed is shrinking it’s balance
sheet, they are letting securities they hold mature without purchasing as much in any given month.

The ultimate goal is to wean the economy off what the Fed considers abnormal money supply to reduce demand without pain and to bring inflation back to its target of 2% without creating excessive unemployment.

Paul Hoffman

Managing Editor, Channelchek

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Image Credit: Karolina Grabowska 

Does a Flat or Inverted Yield Curve Still Indicate Recession?

The shape of the treasury yield curve is one indicator the stock market, bond market, and real estate markets are viewing the economy with pessimism. Historically, conventional wisdom has been that if the market has priced rates lower for longer terms than shorter terms, it indicates economic weakness is expected down the road. This would include lower growth, less demand for borrowing, and at the same time, reduced inflationary pressure.

Current Interest Rates

Currently, US Treasuries maturing in one year, and those maturing in 30 years return approximately the same interest rate. The seven and ten-year terms offer rates lower than maturities, longer and shorter. This flat yield curve which is inverted in the shorter end, offers low yields across all maturities. Can we assume it means bond investors expect slowing growth, low inflation, and low inflation out for decades?

Source: US
Treasury

Current Inflation

The increase in the price for a set basket of goods as measured by the Consumer Price Index (CPI-U) data was up 1.3% for the month of June (9.1% YoY). If inflation were to remain at June’s pace for the next two months (1.3%), the three-month compounded impact would be 3.95%. Much higher than the current three-month treasury yield. In fact, it would be higher than all other yields out through 2052. This suggests the mechanisms pricing the market aren’t looking at inflation expectations in the short term and may not be evaluating the risk in the long term either. Otherwise, within the shortest periods of time (3 months), one would expect the curve to be priced in-line with the most recent inflation numbers.

Source: Peter
G. Peterson Foundation

Using conventional wisdom, with the yield curve as a gauge, one would surmise the market expects that inflation will drop by half of the 1.3% it recorded in June over the next month.  If this is true, then the short end and perhaps the long end is priced appropriately. That is until one looks at the added supply that has already been added to treasuries outstanding and that which is expected to enter the market. The increased supply, based on conventional wisdom, should increase the yields needed to sell all the bonds. That’s how supply-demand pressures work.

Unconventional Yield Curve Pricing

The yield curve as an indicator of future economic expectations may be broken.

The U.S. has amassed $30,515,000,000,000. In debt. Put another way, if every single person (not household) split this debt burden in order to pay it off tomorrow, they each would owe $91,668. This is approximately double the amount it had been ten years ago, and it is now higher than GDP. As depicted in the chart below, if you go back ten years to 2012, a period with deflationary concerns, there was a yield difference between two-year and ten-year treasuries of plus 1.25%. Today it is negative 0.19% even though there is record inflation and less ability to pay the debt. Plus all rates on the upward sloping curve were higher in 2012 than they are now. Should two-year and ten-year maturities be inverted? Should rates across the curve be lower now even though there are not the same deflationary concerns?

Source: St. Louis Federal Reserve Bank

What May Be Shaping the Curve

One possible answer is the (bond) market believes the US will be driven into such a deep recession that inflation drops to near zero within the next few months. There is no evidence of this in any leading indicators, including the stock market. So we’ll look to see if there is something else skewing the normal pricing mechanisms?

Since May of 2020, the Fed has been controlling interest rates along the entire curve by something they call Yield Curve Control (YCC). The chart below shows the Fed’s holding of US debt increased by $5 trillion from 2020 until today. Much of this was to manipulate the yield curve as they openly announced they would do in May 2020. It was part of their quantitative easing plan which continued into the second quarter of this year.

The Fed is now raising overnight rates quickly. A massive amount of debt in the mid and longer parts of the curve is still being held by the Fed and being unwound at a pace of less than $50 billion per month with the promise of accelerating that in pace September.

Source: St. Louis Federal Reserve Bank

It makes sense that the (bond) market reaction, which includes a flight to quality into US dollar-denominated securities, is not pushing longer rates steeply upward. Despite an annual inflation rate that is higher than it has been in 40 years (treasuries were paying 13% in 1982), the bond market is inverted and hasn’t sold off significantly. This cycle it can’t sell off too much because the largest holder, by far, is not market driven. It is the Fed and is using unconventional policy announced two years ago. So the results don’t follow convention.

Are We Headed Toward a Recession?

The yield curve is slightly inverted. A steep inversion has in the past been a reliable indicator of a recession ahead. As an indicator, today’s yield curve can be expected to be far less accurate than in the past. This is because the Federal Reserve has, up until very recently, been buying treasuries to stimulate the economy and help shape the yield curve. The lowest part of the curve, one year and longer, is the 10-year Treasury note. This is the rate that 30-year mortgages are spread off of; should that rise too quickly, the housing market may fall at an uncomfortable pace.

The economy may very well be in a recession or enter one in the coming months. If it does, the current signs of this happening are less likely to be found in the yield curve than at any other time in US history.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://fiscaldata.treasury.gov/datasets/debt-to-the-penny/debt-to-the-penny

https://www.pgpf.org/national-debt-clock#:~:text=The%20%2430%20trillion%20gross%20federal,that%20it%20owes%20to%20itself.

https://fred.stlouisfed.org/series/T10Y2Y

https://research.stlouisfed.org/

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For The First Time In 20 Years, 1 Dollar = 1 Euro. What This Means For Gold

If you were considering taking the family on a European vacation, now may be a good time, as the U.S. dollar and euro just achieved parity for the first time in 20 years.

But as someone who was recently in Europe, I urge travelers to be aware that prices have skyrocketed everywhere, not just in the U.S. A five-star hotel in France or Italy that might have cost $350 a night before the pandemic can now cost as much as $1,600.

This article was republished with permission from Frank Talk, a CEO Blog by Frank Holmes of U.S. Global Investors (GROW). Find more of Frank’s articles here – Originally published July 18, 2022.

Much is being made about the USD/EUR exchange rate, but the truth is that King Dollar has made epic gains on a number of world currencies this year as the U.S. has embarked on an aggressive monetary tightening cycle to control inflation. Below you can see how much G-10 currencies have fallen in 2022 compared to the greenback.

A stronger dollar is favorable not only for Americans traveling abroad but also companies that pay to import goods from other countries—think big-box retailers such as Walmart, Target, Home Depot and Dollar Tree.

On the other hand, a soaring dollar can hurt U.S. exporters since it makes goods more expensive to foreign buyers, dampening demand. Between January and May of this year, the top U.S. exports by end-use included crude oil and petroleum products, mostly due to the massive increase in crude prices. Other top exports included pharmaceuticals, industrial machinery, semiconductors, automotive parts and accessories, fuel oil, automobiles, natural gas and plastic materials, according to Bureau of Economic Analysis (BEA) data. 

Boeing Reports Best Month For
Deliveries Since 2019

The single largest U.S. exporter in value terms is Boeing. The massive aerospace company, which recently moved its headquarters to Arlington, Virginia, faced a wave of order cancellations stemming from the tragic 2018/2019 crashes involving the 737 MAX, but orders look to be picking up again. As I shared with you last week, Boeing reported stellar delivery results for the second quarter, with 51
aircraft delivered in June alone. That’s the company’s best month since March 2019.

I will be curious to see if Boeing executives address the impact of the stronger dollar when the company reports second-quarter financial results later this month.

King Dollar Pushes Gold Deep
Into Oversold Territory

Among the biggest victims of King Dollar’s strength is gold, which, like most commodities, is priced in the greenback internationally. The yellow metal has long been valued as a safe haven during times of economic uncertainty and high inflation, which we’re certainly facing today. June’s consumer price index (CPI) came in at a scorching annual rate of 9.1%, the highest in over 40 years, but if we use the inflation methodology from 1980, the figure is closer to 17% or more.

Despite this, gold has steadily fallen since its 2022 high of $2,070 per ounce, set in early March. As of today, gold is off close to 7% for the year, and last week it briefly traded below $1,700 for the first time since March 2021. Based on the 14-day relative strength index (RSI), the metal looks incredibly oversold at around 23, the lowest it’s been since August 2018.

In addition, gold has signaled a “death cross,” which occurs when the 50-day moving average dips below the 200-day moving average.

Some investors and traders see this move as a bearish sign. I see it as a buying opportunity. If you believe that the dollar is overextended relative to other currencies, and that a reversal could happen in the coming weeks and months, now may be a good time to accumulate, especially if you think we’re in the midst of a recession.

Deepest Yield Inversion Since
2000

I’ve shared with you a couple of times that we may very well be in a recession already, based on the Atlanta Federal Reserve’s GDPNow real-time forecast. The latest forecast, as of last Friday, is that the U.S. economy contracted 1.5% in the second quarter, following an annual decrease of 1.6% in the first quarter.

Even if that ends up not being the case, the bond market is telling us that a pullback may be imminent.

A yield inversion occurs when the shorter-term Treasury bond trades with a higher yield than the longer-term Treasury. Remember, bond yields go up when prices go down, so when yields invert, it suggests that investors find shorter government notes riskier to hold than longer-dated ones.

Inversions have been extraordinarily accurate at predicting recessions. Going back at least 40 years, every recession has been preceded by an inverted yield curve, using the two-year and 10-year Treasuries.

Not only is the yield curve inverted right now, but it’s inverted at the biggest point since the year 2000, soon before the dotcom bubble burst.

So what does this mean? Past performance is no guarantee of future results, but we could be looking at a pullback, if not this year then the next. More specifically, stocks and other risk assets may not have found a bottom yet. From its all-time high in early January, the S&P 500 has fallen 20%, but historically it’s dropped as much as 35% on average when a bear market coincides with a recession.

Do with that information as you wish, but I believe it’s wise and prudent to have exposure to gold at this time, between 5% and 10% of your portfolio.

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US
Global Investors Disclaimer

The NYSE Arca Gold Miners Index is a modified market capitalization weighted index comprised of publicly traded companies involved primarily in the mining for gold and silver. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies. Free cash flow (FCF) represents the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. Frank Holmes has been appointed non-executive chairman of the Board of Directors of HIVE Blockchain Technologies. Both Mr. Holmes and U.S. Global Investors own shares of HIVE. Effective 8/31/2018, Frank Holmes serves as the interim executive chairman of HIVE.

Holdings may change daily. Holdings are reported as of the most recent quarter-end. The following securities mentioned in the article were held by one or more accounts managed by U.S. Global Investors as of (09/30/2021): Torex Gold Resources Inc., Centerra Gold Inc., Gran Colombia Gold Corp., Dundee Precious Metals Inc., Pretium Resources Inc., Endeavour Mining PLC, Barrick Gold Corp., Eldorado Gold Corp., SSR Mining Inc., Silver Lake Resources Ltd., Karora Resources Inc.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. By clicking the link(s) above, you will be directed to a third-party website(s). U.S. Global Investors does not endorse all information supplied by this/these website(s) and is not responsible for its/their content.

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Dollar Strength Impacts Commodity Prices, Money Flow, and Worldwide Inflation

As the dollar strengthens against world currencies, US exports and everything else priced in dollars experience additional inflation as it’s exchanged back to the trading partner’s native currency. This is dampening demand, slowing the rise, and perhaps helping to bring down prices of commodities transacted in US dollars.

The US dollar index expressed as DXY began the year at 96.21 versus a basket of currencies and is now valued at 106.55 against the same basket. So it has gained over 11% since the beginning of the year. After 20 years of trading below the euro’s value, the US currency has recently met and even exceeded parity with the euro. 

Source: Koyfin

Commodities have been falling in response to worldwide economic stagnation and expected weakness for some time. As the dollar has continued to rise, the trend for commodities priced in US dollars has been in decline. This keeps costs closer to neutral for foreign buyers. Since the beginning of June, trends appear to show that commodities are largely hinged, with a negative correlation, to US dollars. These commodity prices may remain under downward pressure unless there is a correction in the US currency.

Prices of oil, metals, and grain shot up earlier this year in response to Russia’s invasion of Ukraine. These markets are now trading based on dollar conversion rates and expectations that central bank activities will cause a global recession. Additional lockdowns in China are also impacting demand. Copper has slipped below $7,000 a ton for the first time since September 2020, and it is down 27.4% year-to-date.

As economic weakness is expected, investment portfolio risk has come off, and the move out of foreign equities, foreign currencies, and commodities has brought in buyers of US Treasury bonds (transacted in dollars). Other traditional safe havens like gold, yen, or Swiss francs are not attracting much interest.

The Bank of Japan (BOJ) and the European Central Bank (ECB) are scheduled to hold their respective monetary policy meetings in the coming week. The BOJ is expected to maintain its extremely easy money policies. The ECB is expected to begin a cycle of raising rates. This could help unwind some of the strength of the dollar vs. the euro as higher real rates tend to create demand for the underlying method of payment. 

In the US, the Federal Reserve (Fed) has its next meeting on monetary policy next week, beginning on July 26 and concluding on the 27^th. The Fed kicked off a hawkish monetary cycle in March and has raised the magnitude of rate hikes from 0.25 percent in March to 0.5 percent in May and 0.75 percent in June. With accelerating inflation well above the 2% Fed target, the Fed chairman has been resolute in his determination to get back ahead of rising prices.

Take Away

To avert risk and earn better yields, there has been an excess of money flowing to US dollar-denominated investments, especially treasuries. This has played out in the foreign exchange markets in a way that has caused a stronger dollar than we’ve experienced in 20 years versus other currencies.

The strong dollar works to lower the prices of goods denominated in US dollars and then converted to a weakening native currency. This dynamic has been pushing commodity prices lower since the second quarter or before. Also pushing prices lower are expectations of a weaker economy and, therefore, less demand.

The lower commodity prices have a slight dampening impact on US costs of manufacturing. Goods coming to the US from overseas also have a favorable exchange rate; combined, these could take some of the steam out of red hot inflation.

The FOMC meets next week to decide on interest rates. The announcement after the meeting is when the Fed chairman sets expectations going forward. These Fed statements will have as much or more implications for market moves (all markets) then the rate adjustment.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.moneycontrol.com/news/business/commodities/commodities-prices-may-struggle-to-recover-till-substantial-correction-in-dollar-8835411.html

https://www.wsj.com/market-data/commodities

https://www.wsj.com/articles/strong-dollar-fuels-pullback-in-commodity-markets-11658223085?mod=hp_lead_pos2

https://www.wsj.com/articles/falling-commodity-prices-raise-hopes-that-inflation-has-peaked-11656811949?mod=article_inline

https://www.wsj.com/articles/strong-dollar-wins-the-inflation-battle-in-new-spin-on-currency-wars-11657369125?mod=article_inline

https://www.nasdaq.com/articles/what-is-the-dxy-index-2021-03-07

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Image: Christine Daniloff (MIT Stock Image)

A Reimagined System of Federally Assisted Unemployment Payments

Peter Dizikes | MIT News
Office

Unemployment insurance is a lifeline for many people when work goes away. And when times get really bad in the U.S. — in recessions and during the Covid-19 pandemic — Congress has extended the duration of unemployment benefits for millions of workers.

But is there a better way to structure the timing of unemployment insurance? For some workers, benefits arrive too late after an economic downturn to prevent household financial crises; others have needed insurance payments just when Congress has been debating what eventually becomes benefit extensions. To avoid ad hoc policymaking, the federal government could potentially deploy objective “triggers,” such as significant rises in the jobless rate, that automatically extend unemployment benefits when recessions hit.

Now a study co-directed by an MIT economist, based on extensive modeling, examines the effects of automated unemployment insurance policies. Unemployment insurance based on such triggers would not cost more — or less — than the packages Congress has ultimately approved, the results suggest. But an automated system would provide more clarity to workers in times of economic stress.

“There is a cost to the way Congress does it, which is, people face uncertainty,” says Jonathan Gruber, a professor of economics at MIT and co-author of a new paper detailing the results of the study. “Right now, Congress decides at the last minute, or waits until a week or two after benefits expire to extend them. That kind of uncertainty is costly to people.”

By contrast, Gruber observes, “The advantage of automatic triggers is you resolve uncertainty, and it wouldn’t actually cost much more than the existing system because Congress extends benefits anyway.”

The paper, “Should We Have Automatic Triggers for Unemployment Benefit Duration and How Costly Would They Be?” appears in an annual publication of the American Economic Association, AEA: Papers and Proceedings. The co-authors are Gabriel Chodorow-Reich, a professor of economics at Harvard University; Peter Ganong, an associate professor at the University of Chicago’s Harris School of Public Policy; and Gruber, who is the Ford Professor of Economics at MIT.

Unemployment insurance usually lasts for 26 weeks; in theory, when unemployment exceeds certain thresholds, states will extend benefits further. On five occasions in the last 40 years, Congress has extended unemployment insurance nationally, with states administering the benefits.

To conduct the study, the scholars developed a model — they call it the UI Policy Simulator — examining the period from 1996 to 2019 by state. The researchers used Bureau of Labor Statistics data to simulate each state’s labor market, and modeled the outcomes that would result from implementing multiple types of unemployment insurance policies.

For instance, one set of simulations applied what the scholars call a “Sahm trigger” (after economist Claudia Sahm) that would enhance benefits after an increase in the unemployment rate that was 0.5 percentage points above its minimum three-month average over the previous 12 months. Another “tiered” set of simulations extended insurance by 13 weeks when unemployment reached 5.5 percent in a state, 26 weeks at 6.5 percent unemployment, 39 weeks at 7.5 percent unemployment, and 52 weeks at 8.5 percent unemployment. Still another group of simulations modeled “hard” versus “soft” landings based on how long benefits would be extended after the unemployment rate dropped below the triggering threshold.

Overall, the size of the benefits (and hence expenditures) that the model produced was very close to the size of the packages that Congress has approved in the wake of the 2001 and 2007-09 recessions. In theory, therefore, cost is not a huge issue.

One wrinkle the modeling uncovered is that such a system would take hold in labor markets that have not deteriorated as much, meaning that an extension of benefits could be triggered in a state that then quickly dips back under the threshold unemployment rate.

“There’s a tradeoff,” Gruber says. With a lower triggering threshold, “You might get people benefits a month earlier. On the other hand, you run the risk of having ‘false positives,’ where you send people benefits when you think it [the economy] is going to go south, and it doesn’t.”

Still another factor to consider, as the authors write in the paper, “past behavior is no guarantee of future legislative performance.” Codifying an automated unemployment insurance system might help protect workers from a future congressional stalemate over the issue.

Could this type of policy actually become law? Gruber thinks that might require a change in the way the Congressional Budget Office (CBO) scores the policy (that is, evaluates its cost). At present, the CBO is required to compare the cost to having no built-in enhanced unemployment insurance policy at all — even though Congress has repeatedly crafted such measures in times of need. That approach makes an automated policy seem like a new government expense, which can make legislators less likely to back it.

“In some sense the reason we never get automatic triggers is because of the way our congressional scoring works,” Gruber says. However, he observes, “If Congress is going to do it anyway, that has a zero cost from today’s perspective.” Gruber also notes: “I don’t want to [be critical] of the CBO. They’re just following their mandate.”

The duration and amount of these benefits was most recently a pressing issue during the first 18 months of the Covid-19 pandemic, after unemployment soared in the spring of 2020. Within the last year, U.S. unemployment has dropped to lows not seen for decades. But at some future point, unemployment will likely again become a greater concern, suggesting to Gruber that any time would be a good time to consider this kind of legislation.

“Hopefully we won’t forget about it, and we’ll be able to fix the system when we can,” Gruber says.

He adds: “This is really what I think we can do in economics that’s so valuable for the world: use the modeling tools we have to speak directly to policymakers about the things they care about.”

The research was supported, in part, by the Becker Friedman Institute of the University of Chicago, the Harvard Ferrante Fund, and the Alfred P. Sloan Foundation.

 

Reprinted with permission of MIT News ( http://news.mit.edu/)

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US Inflation is a Big Ship to Steer

Inflation has proven itself to be persistent, not transitory. This means the Fed is off-course with its 2% inflation target and will have to steer sharply into rough seas to regain its bearings. The CPI report for June confirms that the forces taking the economy in the wrong direction are still overpowering the largest economy in the world. Federal Reserve Chairman Powell continues to assure us he is at the helm and promises to get on course before we lose more ground. But the U.S. economy is a big ship to steer. Big ships don’t react immediately and take a while to turn. This delayed reaction has in the past caused the Fed to wait and see the response before taking further steps or risk oversteering. Powell’s statements suggest he believes the Fed began the adjustments to course very late, and therefore the greater risk is not doing enough to come-about quickly.

Consumer Prices (CPI) and the Fed

Compared to last year, at this time, the inflation experienced by consumers, as measured by the June update to the Consumer Price Index (CPI), rose to a new four-decade high with an annual rate of 9.1%. This release indicates that for a year and a half, the U.S. has been experiencing worsening prices each time it takes a new read. The rate of inflation year-over-year in May was 8.6%, the expectations were for the 12-month period to uptick to 8.8% – over 9% indicates a worsening, the Fed and the U.S. economy are still being overwhelmed by inflationary forces.

Core prices, which exclude volatile food and energy did decline somewhat. In June the increase for the year measured 5.9%, the May report indicated 5.9%. n, the Labor Department said.

When the FOMC met in May to set monetary policy, all earlier talk from them indicated a 50bp (0.50%) increase in overnight rates. Then, strong economic numbers just before the meeting caused the Fed to take a more aggressive stance and move 75bp.

This new look at inflation is likely to keep the Fed aggressive in its moving the economy toward the Fed’s preferred direction. This would mean the odds of a 75bp increase after the FOMC meeting on July 27 have increased. The odds are even further enhanced as Bureau of Labor Statistics (BLS) reports show the economy is still supplying plenty of jobs.

The markets are like passengers on an off-course ship, and the voyage is far from over. Based on market action before and following the number, the markets are uncertain if they should rejoice and have faith in the “captain” that is finally taking strong action, be concerned that corrective action wasn’t taken sooner, or look at how far off course their portfolios are now and vomit (not to mention the thought of their expected cost of heating fuel next winter).

CPI and the Markets

 Stock futures were trading higher before the CPI report. This may be in part a response to Joe Biden who earlier in the week assured those he serves as the 46^th President that the headline number would look bad, but this is because these numbers look back at data that has already improved. This gives hope that next month’s inflation numbers may come off a bit. After the economic release, interest rates on bonds rose (+0.08% on US Treasury 10-Year) and Stocks traded higher (+.05% on S&P 500). They then reversed with bond yields dropping below the open and stock indexes rising.

The market volatility indicates that players in both markets don’t know if they should be comforted by the “bad” number and the Fed’s resolve to react, or concerned about the Fed’s potential to overreact and cause an extended decline in economic growth (recession).

CPI and Consumers

The Fed and seemingly the White House is trying to prevent consumer expectations of higher inflation becoming entrenched. Expectations can be self-fulfilling. Fed Chairman Jerome Powell has said the central bank wants to see clear evidence that price pressures are diminishing before slowing or suspending rate increases. This gives the consumer confidence that the Fed has the tools and is resolved to bring down prices. If this sets expectations it will go a long way in becoming self-fulfilling.

Take Away

The U.S. economy is the largest in the world. In order to impact its components, such as inflation, big steps need to be taken. If they are not taken early, and with enough force, very little happens. The Fed did not attack inflation early for various reasons. After being reaffirmed for a second term, Fed Chair Powell told the markets inflation is more persistent than expected and that he would move to bring it down.

The CPI numbers have been getting worse, this tells the markets the Fed will react with more force. There are fears that this force will cause a recession, the recessionary fears are keeping rates below where they would ordinarily trade with such high inflation and a hawkish Fed. It may be that the fixed income markets are looking too far out into the future, or they just don’t expect a very hawkish response from the Fed.

There is a saying among investors, “don’t fight the Fed.” Based on interest rate moves the bond market does not believe the Fed is resolved, or perhaps they are prematurely pricing in oversteering. The stock market has been moving up since mid-June. This could indicate participants believe the markets were priced for a worse scenario than is currently unfolding for corporate America.

Paul Hoffman

Managing Editor, Channelchek

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Strong Dollar Investments and the Unique Variables in the Second Half 2022

The U.S. dollar has reached parity with the Euro for the first time in 20 years. The 1:1 exchange rate is the result of substantial strengthening of the U.S. currency against much of the world’s mediums of exchange. Year-to date the dollar is up 12.8% against a basket of currencies. This includes the Japanese Yen, which lost 15.8% against the dollar, and the Chinese Yuan, down 5.5%.

Much of the dollar strength can be attributed to the U.S. being more determined to raise interest rates in an effort to stave off inflation. Assets tend to move toward higher interest rates which then tend to fuel a currency’s strength. The Fed has been raising interest rates and has indicated it is resolved to do what it takes to break the inflation trend before it becomes embedded longer term. This is at least the abbreviated explanation I tell friends booking trips overseas this summer. The longer-winded answer is probably more complicated. These complications impact whether investments that normally do well in an upward rate environment should be embraced by investors in today’s rising rate, stronger dollar scenario.

Source: Koyfin

What Else is Behind Worldwide Asset Flows?

There is a lot of uncertainty around the globe. Historically the dollar and dollar-denominated U.S. markets have been considered the relative safest. This safe-haven status brings in money during uncertain periods. 

Europe has been slower to tighten policy than the U.S. despite inflation rates. This has been one of the chief causes of Euro weakness. The region has more factors pushing it toward a recession as economic activity is being stunted by the Russia-Ukraine war. This has caused the European Central Bank to delay monetary tightening, thus producing imbalances between holding Euros vs. holding dollars.

Japan, has been using YCC or yield-curve
control as a way to actively manage its borrowing costs across different maturities. At the same time, they are expanding currency in circulation in order to engineer higher inflation to counter their nearly 40 years of deflation. As one of the consequences,  the yen recently hit a 20-year low against the dollar.

China, Recurring implementation of a zero-Covid policy continues to dampen any economic gains and weaken expectations of economic growth in the future for the manufacturing powerhouse. This has caused its central bank to further ease policy which has had a depreciative effect on the yuan.

Investors Looking at Unique Variables

What stocks do best with a strong dollar? Well, it may
be different this time. For instance, commodities such as oil most often move in the opposite direction of the dollar. But since late February, the beginning of the European war, the dollar and oil have both been on an uptrend. Commodities-based inflation remains in large part to the impact of the war coupled with commodity supply problems caused by steps taken to reduce Covid19 spread.

A strong U.S. dollar also tends to negatively impact international emerging markets that rely on dollar-denominated debt. These borrowers then have to service this debt in dollar-denominated payments – while the dollar becomes more expensive. The unique set of circumstances today has many emerging market regions in comfortable shape, with ample non-native currency reserves. For example, much of Latin America which supplies fuel, food fertilizer, and metals actually stand to benefit from the global supply shortages.

The uncertain economy and leariness of a recession in the U.S. has caused many U.S. market investors to gravitate toward defensive stocks, retailers, particularly those that are big importers, are seeing more activity.

The Fed Faces with New Challenges

The soaring dollar creates additional confusion for the Fed which is charged with guiding monetary policy. Money flowing into U.S. markets and being parked in U.S. treasuries serves to bring rates down at a time when higher rates are deemed needed.

From an inflation standpoint, imported goods will have reduced price pressure after the currency translation for Americans. The increased purchasing power of consumers and businesses when it comes to imports serves to ease inflationary pressures. But the dollar’s strength will slow U.S. exports and the translation of overseas profits by U.S companies.

Take Away

The old standbys for investors when the dollar is strengthening may not be the best moves this time around. The factors creating the strength are different than most cycles. There appear to be opportunities in companies with operations in Latin America that supply goods being thwarted from other regions.

Cycles always give way to a new phase and the current U.S. dollar strength will eventually give way to a new set of circumstances. Stay in touch with the markets with insight and research you find no place else. Sign-up for daily Channelchek updates in your email.

Paul Hoffman

Managing Editor, Channelchek

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Sources

https://www.cnn.com/2022/07/12/investing/euro-dollar-parity/index.html

https://www.morganstanley.com/ideas/thoughts-on-the-market-sheets

https://www.morganstanley.com/ideas/strong-dollar-investing-risks-mount

https://www.stlouisfed.org/publications/regional-economist/october-2015/aging-and-the-economy-the-japanese-experience

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Fed Chairman Powell Attacks the Core of Persistent Inflation

Economics is a social science; as such, it deals with human behavior. While economists are best known for reviewing statistics and plotting data points, those stats and chart plots all represent behavioral trends. Federal Reserve Chair Jay Powell is an economist that understands human behavior; that’s why he is resolved to get inflation back down to “acceptable levels” quickly. He knows what happens if higher price trends remain in place for too long.

The Fed Chair had been guiding the markets and businesses to expect a 50bp increase following the last FOMC meeting. When an inflation report a few days earlier indicated no lessening of the upward price trend, he became comfortable that moving 75bp instead of 50bp would not be going too far.

Federal Reserve officials have indicated they accept the risks of tightening to the point of causing a recession. This is because they are determined to prevent something they view as more difficult to treat. A prolonged upward spiral in prices would change consumer thinking and expectation. An expectation of ever-increasing prices could become self-fulfilling. Higher inflation at times is caused by expectations that prices and wages are going up, not by other underlying dynamics.

Inflation was part of the mindset of anyone who lived through the 1970s, increased costs were expected, and it was prepared for. Since the 1990s, when technology advanced at a rate where we became conditioned to wait for prices to come down, the risk of deflation had been the greater concern. Not today, a number of factors, including fiscal and monetary reactions to the pandemic, sanctions against Russia, and supply chain disruptions, have ignited inflation over the past year. Should it last long enough to become “the new normal,” it will be far more difficult to extinguish.

Powell said that people still expect inflation to come down in the medium and long run. He also said, the longer it takes to restore price stability, the greater the risk that those future expectations could rise. If that happens, he indicated, the U.S. could shift to a high-inflation regime. That could force the Fed to raise interest rates to even higher levels to break the stronger binds.

“We have high inflation running now for more than a year,” Powell said. “It would be bad risk management to just assume that those long-term inflation expectations will remain anchored indefinitely in the face of persistently high inflation. So we’re not doing that.” He asked, “Is there a risk that we would go too far? Certainly, there’s a risk, but I wouldn’t agree that’s the biggest risk to the economy.”

 

Take Away

Chairman Powell said at a central banking forum in Portugal. “The biggest mistake to make…would be to fail to restore price stability.” Inflation rises when demand for goods and services exceeds what is available, the pandemic lockdowns created shortages. Prices also rise when there is too much money chasing those goods. Again, the reaction to the pandemic created another key ingredient. Powell has little control over the supply of goods, but he does have the ability to control the amount of money and the cost of that money. And he intends to make it tight.

His approach is to kill the “cancer” before it becomes pervasive – even if the effort knocks the patient for a painful but survivable loop. At the root of this approach is the fear that households and businesses will come to expect high inflation to persist, which then can cause it to continue. That scenario would require the Fed to increase rates even more. Instead, he thinks it best to rid the country of it ASAP.

Paul Hoffman

Managing Editor, Channelchek

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https://www.politico.com/newsletters/morning-money/2022/06/30/where-jay-powell-draws-the-line-00043362

https://www.postgrad.com/subjects/social_sciences/overview/

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As the Treasury Matures Billions in Federal Reserve Holdings High Rates Could Squeeze the U.S. Budget

Have you ever taken out a 0% introductory rate credit card, ran up a bunch of charges on the low intro rate, and then had it reset to normal. It can be difficult to even keep up with interest payments, let alone chip away at the principal. Well, this is the situation the U.S. Treasury may find itself in as the Fed tightens from 0% at the beginning of 2022 to 3.50%, 4.50%, perhaps even higher before they find the terminal level that provides their desired 2% inflation target.

The seldom looked at dynamic of higher interest rates is that the U.S. Treasury is a huge borrower and that every basis point (0.01%) adds up. At the same time, the price of everything it purchases to run the country is subject to the same inflation dynamics gripping the rest of the world.

Since February 2020, already elevated national debt levels grew from $17 trillion to $24 trillion. Of this increase, $3.3 trillion would wind up owned by the Federal Reserve as part of their experimental
monetary policy. The U.S. Treasury positions owned by the Fed ballooned from $2.5 trillion in February 2020 to $5.8
trillion. Now Fed Chairman Powell is looking to cash in hundreds of billions of this debt to the U.S. Treasury without buying new issue debt.

The costs associated with this extra interest expense to the Treasury, without any additional benefit to citizens, may be felt in the form of a tighter national budget as interest costs grow and crowd out less immediate expenses. And interest costs do need to remain a priority; even the hint of default could drop the U.S. Government bond rating from S&P, Moody’s, or Fitch rating services. This would be devastating to the country’s overall ability to provide what we have come to expect as the basics. And it is something U.S. Treasury Secretary Janet Yellen would certainly not want to happen during her tenure.

The Part Q.T. Plays

Quantitative tightening (Q.T.) never fully got traction after the quantitative easing (Q.E.) that was implemented to deal with the 2008 financial crisis. As a reaction to fears of what the novel coronavirus might do to economic activity, a more aggressive, in size and format, Q.E. was put to work. In May, the Fed announced plans to begin to mop up all the extra money in the economy from bond purchases as part of past Q.E. strategies.

The announced plan is to reduce its Treasury holdings by $330 billion by the end of the year and by $720 billion annually until its balance sheet shrinks to a size deemed stabilizing at an inflation rate consistent with economic health. The Department of Treasury needs to give the Federal Reserve the loaned money back.

The Treasury has had the benefit of rolling higher interest rate maturing debt into lower interest rate bonds. This allowed them to increase their debt dramatically while federal interest costs barely increased despite the $7 trillion increase in Treasury debt. Using the 0% introductory credit card rate analogy, if a consumer moves $5,000 in debt from a 16.99% credit card to a 0% card, they can pile on almost $4,000 more in additional debt and still have a lower minimum payment. When the rate rises, a voluntary pullback has to be made by the consumer, as the interest servicing becomes a large budget expense.

Over the last three fiscal years ending on Sept. 30, 2021, the national gross interest cost was $573 billion, $523 billion, and $562 billion. These days are gone. Short-term rates have risen 1.5% following the Fed’s 75-basis-point rate hike in May and two smaller increases earlier this year. By the end of 2022, additional rate increases are expected to bring total rate increases to 3%, according to the Federal Reserve’s official guidance. The Fed projects short-term rates averaging 3.4% in December with a bias toward increasing next year.

As this additional 3% works its way into the refinancing of maturing Treasuries, federal interest costs will compound. There are about $3.7 trillion in outstanding Treasury bills, maturing in less than a year. Over 12 months, a 3% increase in rates would add to near $111 billion in additional annual interest expense on this outstanding debt.

There are $2.4 trillion Treasury notes (USTN) maturing within a year (notes are ten years and shorter, bonds are ten years and longer otherwise, there is no difference). The weighted average interest rate on these notes is 1.3%, and the weighted average original maturity is 4.7 years. So, to make the math easy,  to replace it with a similar average maturity (current five-year Treasury note) the Treasury would incur a yield of about 2.91% (today’s five-year yield). And this is after a substantial rally last week. Rolling this maturing debt is expected to cost the Treasury near $85 billion in additional interest rate costs.

Total federal gross interest cost over the 12 months ending on May 31 was $666 billion. Looking at the above maturing Treasury debt over the next year, we can calculate the additional interest cost to be near $860 billion. This is a cost for which citizens receive nothing. By comparison, the Medicare system’s annual cost is $700 billion, and military spending over the past 12 months was $746 billion.

 

Take Away

There’s an item on the U.S. budget that will be skyrocketing. This is part of the price of fighting inflation. Paying the added cost could come from reduced spending (unlikely), increased taxes (not politically popular), or new debt (the usual solution).

The Federal Reserve’s plan to raise interest rates through Q.T. and raise overnight interest rate targets will bring the cost of government borrowing up. There are very few who will benefit from this.

One group that may are those that have been living on a fixed income and have depended on interest rate products like bonds, C.D.s, preferred stocks, and even dividend-paying common stocks for their income. This group has been on a tighter budget than they have expected for a long time, and some have given up hundreds of thousands in income since 2008. They are finally going to get paid again on their savings. Let’s all hope this serves as a kind of stimulus “check” for this large demographic that keeps the economy moving forward and providing opportunities.

Paul Hoffman

Managing Editor, Channelchek

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https://fiscaldata.treasury.gov/datasets/monthly-treasury-statement/summary-of-receipts-outlays-and-the-deficit-surplus-of-the-u-s-government

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https://fiscaldata.treasury.gov/datasets/monthly-statement-public-debt/summary-of-treasury-securities-outstanding

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Michael Burry’s Recent Fed Tweet Has Implications for Most Investors

The Federal Reserve receives splashy headlines when they up the overnight lending rate that banks charge one another. But Federal Reserve Chair Jerome Powell had laid out a schedule for something that is arguably more significant than a Fed Funds adjusted target – the schedule massively and methodically shrinks the Fed’s balance
sheet. Michael Burry noticed that the Fed has quickly veered from its quantitative tightening plans. He took to Twitter to let those of us in the markets know about it. The information he shared in a Tweet is important
to investors of stocks, bonds, and even real estate. What did Michael Burry’s 36 words say, and what else do investors need to know? 

About Burry’s Tweet

The hedge-fund manager that became world-renowned after being portrayed in the movie “The Big Short,” compared the Federal Reserve’s unresolved, high level of economic stimulus to the difficulties of drug addiction. He tweeted: “Drugs are hard to kick. Fed was supposed to sell $30B Treasuries and $17.5B Mortgage-Backed Securities per month starting June 1. Q.T.” He continued, “During June, MBS holdings rose almost $3B. Treasury holdings fell less than $10B.”

Source: @BurryArchive (Twitter)

Burry’s tweet refers to the Fed’s plan to reduce U.S. Treasury holdings by $30 billion for the months of June, July, and August and by $17.5 billion in mortgage-backed securities during these same months. This would effectively pull $47.5 billion in cash from the U.S. economy and would cause the new issuance replacing (actually funding) this maturing debt to need to find new buyers. New buyers are attracted when Treasury auctions to replace the maturing debt reach a high enough interest rate bid to sell every last penny. The Fed’s guidance meant that, at least for Treasuries, $30 billion non-Fed dollars would need to be attracted at Treasury auctions.

Is It True?

The holdings of domestic securities by the Fed are reported each week on the New York Fed website. Using the last week in May, and the last week in June, it would seem the Fed has only reduced its holdings by $7,419,485,200 overall. This is a $40 billion miss from Fed guidance given as recently as May.

The math can be refined using the website by drilling down into the holdings more, but Michael Burry’s tweet asserts that they added $3 billion in MBS, and Treasury holdings are only down by $10 billion. The $7 billion roughly equates to netting the difference between the two SOMA holdings; this is the total difference between the Fed’s two statements, four weeks apart.

What Does it Mean for Investors?

If, as an investor, you determine your positions by connecting “economic dots,” and you’re told by the Fed that they are transparent and that this is what you can expect from us if nothing changes, you align your positions according. That’s a fairly substantial “dot.”  For Michael Burry,  there is nothing I can see on his company, Scion Capital Management’s,  most recent SEC
13-F filing that would indicate he specifically used the Fed’s guidance, however, this 13-F is from May 16.

Investors inclined to trade on money supply, or interest rates, may have taken positions based on the Fed’s advertised transparency and guidance for the few months forward. One could imagine a scenario where investors would see the Fed’s activity serving to steepen the yield curve. This could have caused investment in stocks of some banks. Banks with a substantial portion of their earnings made from lending would benefit from a curve where the longer rates increase faster than shorter rates. A natural result if the Fed followed its plan.

The promised decrease in mortgage-backed securities could cause some real estate investors to pull back substantially, or at least more than they would have if they had known the Fed would actually increase its position.

Michael Burry is best known for his ability to spot what to short and how to short it. The Fed guidance would indicate that rates on longer-term Treasuries would rise with the $30 billion per month reduced holdings by the Fed. This would mathematically drive prices down with each uptick in rates. The actual number for June was closer to $10 billion. Not only would this lack of Fed follow-through in June mess with investor positions, it leaves in question whether Powell will be equally cavalier about promised future reductions. The Fed laid out a schedule where it would increase its reductions beginning in September. Investors, presumably Michael  Burry among them, now don’t know what to think. 

Paul Hoffman

Managing Editor, Channelchek

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What Will It Take to End Rampant Home-Price Inflation?

Real wages are falling, inflation is at a forty-year high, and the Atlanta Fed predicts we’ll find GDP (gross domestic product) growth at zero for the second quarter. Meanwhile, both the yield curve and money supply growth point to recession.

But when it comes to the latest data on home prices, there’s still no sign of any deflation or even moderation. For example, the latest Case-Shiller home price data shows home prices surged above 20 percent year over year in April, marking yet another month of historic highs in-home price growth. It’s now abundantly clear that a decade of easy money, followed by two years of covid-induced helicopter money, has pushed home price growth to levels that dwarf even the pre-2008 housing bubble. This continues to make housing less affordable for potential first-time home buyers and for renters. Unfortunately, the options for “doing something” are limited, and probably require a recession.

But in the meantime, those who are already lucky enough to be property owners continue to see some big gains. According to the latest Case-Shiller home price report, released Tuesday (June 28):

Source: Case Schiller Home Report

According to the index, year-over-year changes have exceeded 18 percent for each month since June 2021, a rate well in excess of the growth rates experienced during the housing bubble leading up to the financial crisis of 2008. This growth is also reflected in month-over-month growth, which has not fallen below 1 percent in twenty-one months. In other words, as of April, there was still no sign at all that price inflation and declining real wages were doing much to dampen demand for home purchases.

Image: Case Schiller

The reader may remember that price inflation began to surge well above the Fed’s target 2 percent rate as early as April 2021. Price inflation hit forty-year highs of more than 8 percent during early 2022. Moreover, April of this year was the thirteenth month in a row in which price inflation outpaced growth in average earnings.

Housing Is Less Affordable, But There Are Plenty of Buyers

People are getting poorer in real terms, so it’s not surprising that April data also shows historic imbalances between disposable income and home prices. As of April 2022, the Census Bureau’s estimate for the average sale price of new houses sold reached 10.3 times the size of disposable personal income per capita. The average home sale price has been more than nine times disposable income for the past six months of available data. In recent decades, home prices have only been this unaffordable in periods leading up to recessions and financial crises—i.e., 1980, 1991, and 2007. April’s home-price-to-income ratio is higher than in any other period in more than forty-five years.

Image: Case Schiller

One reason the April data showed no sign of declining home prices is that employment data—a lagging economic indicator—still showed a relatively strong job market. Although total nonfarm employment remained below 2019 precovid levels, job growth was strong enough to combine with monetary inflation and fuel big growth in prices—an ongoing trend. Moreover, as of April, mortgage rates had not yet climbed out of very-low-rate territory. The average thirty-year fixed rate did not even reach 5 percent until mid-April. This, combined with continued job growth, helped keep demand high. (As of mid-June, however, the average thirty-year fixed rate is 5.8 percent, a thirteen-year high.)

So What Will it Take Before We Begin to See Any Real Reductions in Home Prices?

Unfortunately, the only real way out is probably a recession. This is thanks to a mixture of the regime’s fiscal and monetary policies. After so many months of reckless monetary inflation fueling out-of-control demand, all that newly created money continues to chase relatively stagnant supply. Supply has been hobbled by lockdown-induced logistical bottlenecks, US sanctions on Russia, and rising energy prices due to the regime’s war on fossil fuels. Thus, consumers can’t benefit from the sort of supply-driven disinflationary forces that helped keep price inflation at manageable levels during many periods in the past. Now, we’re just left with surging demand fueled by new money, without the market freedom necessary to provide breathing room through supply growth.

Will the Fed Tighten Enough?

Fed chairman Jerome Powell denied at this month’s Federal Open Market Committee meeting that the Fed is trying to bring about a recession to rein in price growth. But whether or not that is the intent, even the Fed’s very mild tightening has already accelerated the US economy’s slide toward recession—or at least toward job losses. For instance, there is growing evidence of sporadic mass layoff events. JP Morgan announced last week “that it was laying off hundreds of employees due to rising mortgage rates amid a troubling housing market plagued by inflation.” Redfin last week announced layoffs for 470 workers. Hiring freezes and mass layoffs are a growing concern in Silicon Valley.

If the US is indeed headed toward job losses and recession, the danger now is of the Fed not backing off monetary inflation long enough and hard enough to actually allow the economy to clean out the malinvestments and bubbles created by the monetary inflation of the past decade. The danger of too-weak tightening has been evident before. For example, the Fed moderately reined in monetary inflation from 1972 to 1974. But these measures proved to be too little to really end the inflationary boom. Thus, malinvestment and price inflation piled up until the early 1980s, when more tightening finally brought inflation under control.

So the question now is this: Will the Fed pull its foot off the easy-money accelerator only long enough to get a few flat months in price inflation and then return to the same old inflationary stimulus policies? That could win a brief reprieve for first-time home buyers and renters in terms of housing prices. But more than a brief reprieve is greatly needed. Of course, what the Fed should do is completely sell off its portfolio and stop manipulating interest rates altogether. But failing that, it needs to at least allow interest rates to rise enough—and shrink its portfolio enough—to allow for some real modicum of “normalization” in the financial sector.

In any case, real deflation—both monetary inflation and price inflation—is necessary, and that can only be accomplished if the Fed can resist the temptation to keep doing what it’s been doing since 2008 with “nontraditional monetary policy” including quantitative easing, financial repression, and bubble creation.

About the Author: Ryan McMaken (@ryanmcmaken) is a senior editor at the Mises Institute. Ryan has a bachelor’s degree in economics and a master’s degree in public policy and international relations from the University of Colorado. He was a housing economist for the State of Colorado. He is the author of Commie Cowboys: The Bourgeoisie and the Nation-State in the Western Genre.

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