Daily Economic Update: March 19, 2024

Yields rose and stocks rose yesterday as encouraging data out of China coupled with better than expected home builder sentiment and of course, to make a trifecta you need something "AI" related in the news.  In yesterday's case, the AI related news was that iPhone's may integrate Google's Gemini (yes the same one that everyone was complaining about the other week).  The 2Y and 10Y yield are sitting around YTD highs at 4.74% and 4.33% respectively.

I wrote this before the BoJ, but maybe the day's excitement will be their first hike since 2007.

So while we wait for more exciting things, like the NCAA Tournament, and I guess the FOMC meeting (oh the suspense of the Dots), I thought I'd share some excerpts from recent economic related articles, all of which seem to imply that economist still have no clue about the current state of the economy and whether interest rates are restrictive.

Our first excerpt comes from the BIS and is on the natural rate of interest, r*.  As a reminder "The natural rate refers to the short-term real interest rate that would prevail in the absence of business cycle shocks, with output at potential, saving equating investment and stable inflation. Hence, the natural rate serves as a yardstick for where real policy interest rates are headed. It is also a benchmark for assessing the monetary policy stance “looking through” business cycle fluctuations. It can be conceived of as representing the intercept in a monetary policy rule, as in a “Taylor rule” (Taylor (1993)). Together with the long-run inflation rate, defined by the central bank inflation target, it pins down the long-run level of the nominal policy rate."  Now here's the interesting excerpts which to me ultimately conclude 

• Moreover, and less often appreciated, monetary policy itself could have a non-negligible effect on natural rates and perceptions thereof, through debt accumulation and beliefs about r*. As such, the recent reemergence of upside inflation risks inducing a tighter monetary policy stance going forward may have pushed at least perceptions of r* higher
• The uncertainty around r* estimates at the current juncture is very high
•  Some developments point to r* remaining at low pre-pandemic levels...trend real growth (though AI may boost that), increasing life expectancies.
• However, other developments point to a potential increase in natural rates...dependency ratios are increasing, fiscal deficits ballooned, the adoption of new technology requires increased investment and geopolitical fragmentation could reverse the global savings glut.
• Some recent studies point to the possibility that expansionary monetary policy may raise r*. Long-lasting positive effects on aggregate demand, so-called “hysteresis effects”, could boost innovation and growth
• By contrast, through the interaction with the financial cycle, prolonged expansionary monetary policy could lower r* over long horizons. This is because monetary policy has a major impact on debt and asset price dynamics. Prolonged monetary easing could therefore fuel debt accumulation and financial imbalances. This could push down r* because high debt burdens can weigh heavily on demand
• These findings caution against over-reliance on r* as a guide for monetary policy. The uncertainty surrounding r* suggests that it is a blurry guidepost for assessing the monetary policy stance and hence the tightness of monetary policy, in particular at the current juncture. In this context, it appears advisable to guide policy decisions based more firmly on observed inflation rather than on highly uncertain estimates of the natural rate. 

The second excerpts comes from Brad DeLong's article "The Mystery of US Interest Rates" and also deals with the neutral rate of interest.  Ultimately he concludes that maybe we're wrong about our estimates of the neutral rate.

• Rates today are far higher – around two percentage points – than the level anyone five years ago (before the pandemic) would have estimated the “neutral” rate to be
• An interest rate that everyone considers to be above the neutral level therefore reflects markets’ confidence that a recession – or at least a substantial slowdown – is only a matter of time. When that time comes, all will depend on whether the Fed recognizes the approaching weakness in time to cut rates and achieve a “soft landing.” This interest-rate configuration has now held for seven months.
• I suspect that the Fed is profoundly uncomfortable with interest rates substantially above what it confidently believes the neutral rate to be, especially now that inflation is very close to its 2% target. But it will not dare to shift out of reverse until it sees signs of slower job growth
• Three explanations could clarify the current situation. The conclusion that interest rates are in excess of the neutral rate could be based on an erroneous analysis. Or there could be an error in how we measure the state of the economy. Or, third, the Fed may have committed the Wile E. Coyote error.  Tackling these in reverse order 
• The near-consensus since the start of the pandemic has been that there are powerful fundamental factors keeping the neutral interest rate very low, and that there have been no major changes to those fundamentals. But if there is one lesson that I have learned in more than 40 years of trying to understand the business cycle, it is that there is no empirical regularity in the macroeconomy that can be trusted not to crumble beneath our feet in a remarkably short time.

The third set of excerpts comes courtesy of John Cochrane's post, "Inflation and the Value of Money" dealing with the problems of measuring inflation and the puzzle of explaining the role interest rates have played in slowing inflation.

• If we measured inflation as we did in the 1970s, the recent bout of inflation would have been even higher than the worst of the 1970s! No wonder the deplorables are ungrateful for Bidenomics
• The main difference is that the old measure counts the price and interest rate you have to pay to buy a new house as the cost of the house, while the new measure is based on what it costs to rent a house
• The new way is closer to right, if the question is to measure changes in the cost of living right now for the average person.
• The world isn’t static. The future matters. The right question might be, how much does it cost today to buy my lifetime consumption?...Buying a house locks in the right to live there forever. The cost of a lifetime of housing did go up, though today’s rents did not....If you want to know the cost of providing for a lifetime of consumption, higher asset prices and lower real interest rates mean that cost has risen. The consumer price index asks a different question. The lifetime consumption cost index would be a fun thing to calculate.
• Background:  Inflation came seemingly from nowhere to most analysts. Summers and I think it was perfectly obvious — drop $5 trillion from helicopters and inflation breaks out. For Summers, that’s simple AS/AD: deficit x 1.5 > GDP gap. To me (fiscal theory) it is central that people do not expect surpluses to pay back that debt anytime soon
• The puzzle for standard analysis is that inflation eased just as the Fed started raising rates, long before rates exceeded inflation, and with no recession. Adieu Phillips curve.
• What is the effect of interest rate rises on inflation? Most estimates say inflation goes up gently for a year or two after a rate rise, before falling gently (maybe). In this context, inflation easing one month after the Fed gently started raising rates is nearly miraculous. Talk shifts to “expectations,” somehow this time a few basis points of short rate showed everyone just how tough the Fed would be.
• Conversely, maybe this observation shows a resolution of the “price puzzle” that historic estimates show inflation rising a while after interest rate rises. Maybe that was all spurious, and inflation really does turn around just as interest rates rise. Getting models to generate a delay has been devilishly hard, and to this day most modern (rational expectations, new Keynesian, forward looking) models say that inflation jumps down the minute interest rates rise. Maybe the models are (whew!) right after all.

XTOD:  Being busy is a form of laziness—lazy thinking and indiscriminate action.  Being busy is most often used as a guise for avoiding the few critically important but uncomfortable actions.

XTOD: Calling CRE ‘Manageable’ Is Just Wishful Thinking  @business   Policymakers calling the roughly $1 trillion of commercial real estate debt coming due this year “manageable” may regret it....If today’s CRE situation is anything like the savings-and-loan disaster, we’re in for a lot of trouble. It culminated in the collapse of hundreds of lenders, the insolvency of the Federal Savings and Loan Insurance Corporation — which cost taxpayers many billions of dollars

XTOD: According to the Boston Consulting Group (BCG), data centers currently represent 2.5% of U.S. electricity consumption. [At higher end of estimates], data centers could move to 7.5% of all electricity. >60% of DCs in MISO, CAISO, PJM, & Southeast.

XTOD: This thing that I am unhappy about, is it actually hard to change or is it simply hard to have the courage to change it?

Daily Economic Update: March 18, 2024

FOMC week is upon us; statement, Dots, Powell presser.  With March Madness upon us and the Fed definitely on hold this meeting, I'm not sure anyone actually cares about this meeting.  At least for the week I'll venture that more predictive power will go towards completing NCAA Tournament Brackets than predicting Fed rate cuts.  Perhaps this is a good thing (see my last FOMC recap here).  Much like improbable upsets will bust many people's brackets, inevitably it will be some seemingly unpredictable event (war, pandemic, financial disaster), not the Fed, that will have the most potential to change the future economic path.

The conclusion to a speech by Ben Graham in 1963 may have summed up the challenge

"The investor must recognize that there are uncertain and hence speculative elements in any policy he follows — even an all-Government-bond program. He must deal with these uncertainties by a policy of continuous compromise between bonds and common stocks, and by adequate diversification. (Exception: He may put and keep most of his funds in shares of a promising business with which he is closely connected.) He must make a strong effort to have more money invested in common stocks at lower market levels (at least on the basis of cost) than at what he recognizes to be potentially high levels. Most important, he must maintain a philosophical attitude toward the inescapable variations in his financial position and the inevitable “mistakes” associated with these variations.

According to an old Wall Street story, when a certain broker was asked by a client to recommend issues to buy, he always asked in return, “What is your preference? Do you want to eat well or to sleep well?” I am optimist enough to believe that by following sound policies almost any investor — even in this insecure world — should be able to eat well enough without having to lose any sleep.

Speaking of the Fed, nothing in the inflation data should inspire much confidence for the Fed's battle with inflation.  Since the Fed loves anchored inflation expectations, the NY Fed Survey of Consumer Expectation showing consumers raising their expectations for future inflation at the three and five year horizons is probably concerning.  Away from the hard data, out in the real world (the one where you pay for gas, airfare, lodging, food, insurance, etc.) there still seem to be some rising prices - at least it seems that way to me anecdotally.  

Away from the Fed there will be plenty of other Central Bank activity with the BoJ, RBA, and BoE.  The most exciting of which is likely the Bank of Japan where there is a decently high probability that they end their negative interest rate policy.

On the week ahead:

Monday: nothing major, work on your brackets,  BoJ 11pm

Tuesday:  Housing Starts & Building Permits

Wednesday:  FOMC 2pm

Thursday:, BOE, March Madness begins (noon), Philly Fed, S&P PMI's

Friday:  Powell speaks at a Fed Listens event, but everyone will be watching basketball

XTOD: When James Madison was penning the First Amendment, I wonder if he thought:  "What we really need is a Constitution that protects the right of the Chinese government to spy on millions of Americans and control how they get information"

XTOD: The Atlanta Fed's gauge of sticky inflation has risen to about 5% on a 3-month annualized basis. Inflation is moving in the wrong direction for the Fed, so it's interesting that the market's base case is still that the Fed is going to cut rates by about 100bp by January 2025.

XTOD: My highest-conviction short is BX.  I have a position.

XTOD: Day 3 of 20 on the road talking to financial advisors and family offices about bitcoin.  Some initial take-aways:.....(skipping to #4) 4) One common theme in conversations (which is new compared to past trips) is a visceral concern about rising US debt levels.  Many advisors have clients who are worried about the US fiscal situation, and are using bitcoin as a release valve for that concern. I think the elections may be a catalyst to bring this concern to the forefront of people's minds.

XTOD:  Let me be blunt ...  Why do people use wealth managers?  Because they are rich! What is the wealth manager's main objective?  NOT TO MAKE THEM POOR.   Wealth managers and their customers do not stay awake at night thinking about how to make a killing. They already have. They stay awake at night, worried about losing it.  Understand this mindset before you make up more takes about rich people via their wealth managers FOMO-ing into crypto.  Yes, they will EVANTUALLY put 1% in crypto. But it will take many years and many cycles for this to become a reality.  Right now, I believe we are seeing " weak hands" piling in, such as asset managers trading accounts, small retail wanting to get rich (so they can give it to a wealth manager!), algos, and high-frequency hedge funds.\

XTOD (condensing a long post): We need to talk about Upper Middle Class Families in America  Or, what used to be Upper Middle Class....In most metros, a combined 100+ hours of work/week between the two of them affords them an even better *material* lifestyle than their parents had: nicer cars, bigger home, takeout meals, and better vacations (during which they check email constantly)  

Essentially, this cohort is now *Upper Class* in material goods lifestyle but not in leisure time....  It requires over DOUBLE the amount of working hours per household to get to this materially better but quality-of-life worse place.....We either:  1.  Work all the time, with a spouse who works all the time, to try and capture that elusive slight upward mobility  OR  2.  We pursue balance but fall behind into downward mobility   The end result?    We are collectively exhausted and feel a sense of aching nostalgia for the way things used to be   And our communities and mental and physical health are worse off for it

XTOD: Overcommitment is the enemy of happiness. Embrace the art of doing less. 

XTOD: 10/10 podcast episode with @ShaneAParrish  and Tom Gayner of  Markel.  https://t.co/vKv9vO0d7b

Daily Economic Update: March 15, 2024

 "Every choice has an impact on the Compound Effect of your life."

"Your biggest challenge is that you've been sleepwalking through your choices.  Half the time, you're not even aware you're making them!"

"It's the little things that inevitably and predictably derail your success. Whether they're bone-headed maneuvers, no-biggie behaviors, or are disguised as positive choices (those are especially insidious), these seemingly insignificant decisions can completely throw you off course because you're not mindful of them."

"..our need for immediate gratification can turn us into the most reactive, nonthinking animals around."

"Indulging in our bad habits doesn't seem to have any negative effects at all in the moment....But that doesn't mean you haven't activated the Compound Effect".

-Darren Hardy, various excepts from The Compound Effect originally published in 2010. 

Daily Economic Update: March 14, 2024

 

Experience, in the peculiar sense we teach them to give it, is, by the bye, a most useful word. A great human philosopher nearly let our secret out when he said that where Virtue is concerned “Experience is the mother of illusion”

              

   -C.S. Lewis, The Screwtape Letters (#28) - "Experience is the mother of illusion" is a paraphrase of a quote from Immanuel Kant: "For as regards nature, experience presents us with rules and is the source of truth, but in relation to ethical laws experience is the parent of illusion, and it is in the highest degree reprehensible to limit or to deduce the laws which dictate what I ought to do, from what is done"

Daily Economic Update: March 13, 2024

There's something wrong with the world today
I don't know what it is
Something's wrong with our eyes
We're seeing things in a different way
And God knows it ain't His
It sure ain't no surprise, yeah

We're livin' on the edge
Livin' on the edge

-Aerosmith 1993 Livin on the Edge  (current societal mood is nothing new)

Daily Economic Update: March 12, 2024

 "Well, ladies and gentlemen, we're not here to indulge in fantasy but in political and economic reality.  America, America has become a second-rate power. Its trade deficit and its fiscal deficit are at nightmare proportions.  Now, in the days of the free market when our country was a top industrial power, there was accountability to the stockholder. The Carnegies, the Mellons, the men that built this great industrial empire, made sure of it because their money was at stake.  Today, management has no stake in the company! All together, these men sitting up here own less than three percent of the company...You own the company.  That's right, you, the stockholder.  And you are all being royally screwed over by these, these bureaucrats, with their luncheons, their hunting and fishing trips, their corporate jets, and golden parachutes."

        

-Gordon Gekko, Wall Street (the movie) 1987 (complaining about deficits and management is a timeless American tradition) 

Daily Economic Update: March 11, 2024

The Federal Reserve is in it's blackout period leading up to their March 20th rate decision.  The week ahead features an important (aren't they all important?) CPI data print on Tuesday,  followed by PPI and Retail Sales on Thursday and UofM consumer sentiment on Friday.

Like the Fed, every so often it's good to cut the noise out of your day, especially in financial markets news.  As Warren Buffet said in the latest Berkshire annual letter [referring to his sister): "She is sensible – very sensible – instinctively knowing that pundits should always be ignored. After all, if she could reliably predict tomorrow’s winners, would she freely share her valuable insights and thereby increase competitive buying? That would be like finding gold and then handing a map to the neighbors showing its location."

So like I did back in December 2023  for the remainder of the week, you'll get one quote/excerpt a day from whatever books, article, transcript, etc. I have laying around.

Speaking of NOISE, here are two quotes to consider to start your week:

"Noise, the grand dynamism, the audible expression of all that is exultant, ruthless and virile.... We will make the whole universe a noise in the end. We have already made great strides in this direction as regards the Earth.  The melodies and silences of Heaven will be shouted down in the end."

                            -C.S. Lewis, Screwtape Letter #22

"that’s the problem is our modern world, with all of its noise, produces a state of constant alert, and that is not optimal. And this would all matter less, but that amid that noise, there is also signal. In the realm of information theory, the term signal refers to the desired meaningful information. While noise is the unwanted interference, transposing this concept into our daily lives, the signal is the crucial work. It’s a heartfelt conversation. It’s the key insight. The noise is everything that distracts or detracts from that, and this constant exposure to noise makes it hard for our brains to filter out the essential from the non-essential. When bombarded by too many stimuli, too much noise, the brain struggles to identify and process the signal. You know the feeling. You’re trying to write a report, and your email notifications keep pinging, annoying emails interfere with the signal writing the report, affecting the quality of your decision-making and clarity, and all of this leads to mental fatigue or cognitive fatigue when the brain is overused. Similar to how our muscles tire after prolonged exertion, constant noise, and distractions demand the brain to switch tasks frequently.

You know what it’s called – context switching. Each switch uses up cognitive resources leading to rapid depletion of our mental energy. So this is why after not even a day but a few hours with constant interruptions, even if they’re minor, you can feel as exhausted as if you’ve done intense physical labor. The fatigue isn’t just about the mental effort of the main task but about the additional energy expended in managing and shifting between distractions, and the fatigue has a compounding effect. As you become more tired, your capacity to differentiate between noise and signal diminishes further, making you even more susceptible to distractions, which in turn increases fatigue. So there’s a vicious cycle that can severely impact mental wellbeing. "

 -Gregg Mckeown, podcast ep. 233 

Daily Economic Update: March 8, 2024

It's another JOBS Day in 'merica.   We'll start with new record highs for S&P and Nasdaq as investors cheer central bankers who sound determined to cut rates this year.  The 2Y is ~4.50% and the 10Y is ~4.09%  ahead of jobs.

As for the jobs report, the consensus is for a headline number of ~200K with the unemployment rate remaining at 3.7%.  The Average Hourly Earnings number might get additional scrutiny after yesterday's BLS data on productivity and unit labor cost data showed YoY compensation per hour at 5.1% (see page 6).   Whatever happens, blame the weather as GS research reports that nationwide snowfall declined substantially in February which might have caused an uptick in construction and leisure jobs.

Yesterday, as expected the ECB kept their key interest rates unchanged at 4.5, 4.75 and 4% for the main refinancing, marginal lending facility, deposit facilities respectively.  The ECB did revise down their inflation projections and expect to get to target inflation in 2025 (on a headline basis) while characterizing the growth in wages as 'strong'.  I guess we'll see if inflation falls as quickly as now forecast by the ECB, if it does it sounds like they'll be cutting by June.

In Fed land, probably the most memorable thing about Powell's testimony will be the questioning from John Kennedy of Louisiana around the allegations of sexual misconduct by bank examiners (see around 4:30 mark).  I get that the ultimate line of questioning had to do with the Basel III endgame in some way, but I'm just not sure what the FDIC has to do with Powell. Unfortunately or fortunately, social media has had their fun with this exchange and it will now be the only thing most people remember from this testimony.

The SOTU was about as expected based on pre speech media reports, with Biden taking an opportunity early in the speech to paint Trump as a threat to democracy at home and abroad. Record job growth featured prominently and there was a soft landing reference in the speech.

XTOD: Did u guys see that bro's expression in the back?  https://pbs.twimg.com/media/GIFPvMtbsAUHMoS?format=jpg&name=medium

XTOD: Powell: "Interest rates right now are well into restrictive territory. They’re well above neutral."

"We're far from neutral now."

XTOD: Oaktree’s Howard Marks says many companies are still "swimming naked" with debt maturities yet to hit. “The tide hasn’t gone out.”

XTOD: Goldman Trader: Back In 2000 Everyone Thought The Internet Would Run On Cisco Routers At 50% Margins... Until They Didn't