Whatever the outcome, pressure certainly seems to be building on foreign currencies and foreign yields, with the UK front and center with GBP at 1Y weakness and UK yields moving into Liz Truss and ‘head of lettuce’ territory with a 30bp move in 10Y yields in just 3 days. It’s kind of crazy, but reflecting on Jimmy Carter and stories of the late 70s, it’s almost hard to believe how much political attitudes towards deficits have shifted towards a lack of real concern over debt and deficits. When you think about the fiscal situation in many economies take a look at the commentary below from John Cochrane.
Let's close out the week with some odds and ends you might find interesting. Next week we’ll attempt to tackle the other side of the meta-narrative, that being that not everything is cyclical and mean reverting. Be on the lookout for that post Monday morning. If you missed the previous posts from this week on business cycles, credit cycles and CAPE, you should read them before Monday.
Before we get to Monday, here’s Buffett and Munger weighing in on the “trees don’t grow to the sky” narrative, with this excerpt from their 1999 shareholder meeting:
WB: "If U.S. GDP grows 4% - 5% a year, with 1% - 2% inflation, which would be a very good result, I think it’s very unlikely that corporate profits will grow at a greater rate than that... You can’t constantly have corporate profits growing at a faster rate than GDP. Obviously, in the end, they’d be greater than GDP. It’s like somebody who said New York has more lawyers than people... So, if you have a situation where the best you can hope for in corporate profit growth over the years is 4% - 5%, how can it be reasonable to think that equities, which are a capitalization of corporate profits, can grow at 15% a year? It is nonsense, frankly. People are not going to average 15% a year or anything like it in equities. I would almost defy them to show me, mathematically, how it can be done in aggregate... The only money investors are going to make, in the long run, are what the businesses make. Nobody’s adding to the pot. People are taking out from the pot, in terms of frictional cost: investment management fees, brokerage commissions, all of that... [Corporate profits] can’t double in five years with GDP growing 4% a year or some number like that. It would produce things so out of whack, in terms of experience in the American economy, that it won’t happen... If you trace out the mathematics of something and bump into absurdities, you better change your expectations."
CM: "There are two great sayings. One is, 'If a thing can’t go on forever, it will eventually stop.' And the other I borrowed from my friend, Fred Stanback: 'People who expect perpetual growth in real wealth in a finite earth are either mad men or economists.'"
Away from the meta-narrative topic, here’s a couple of economic related posts you might have missed.
From Allison Schrager: Risk Management 2025 Style.
I don’t know what will happen, and no one else does either.
I am of the mind that the term premium is the most important of all macro/financial indicators.
Higher rates are back—up and down the curve—and the term premium tells us nearly everything we need to know. If it continues to increase, it suggests a higher growth and risk environment. Which, frankly, is how it should be.
In a higher rate environment, institutional investors will crave less yield, making expensive fees and liquidity lock-ups less appealing. This shift will expose underperforming private investments.
Moving into a high-rate for longer environment will reveal where all the bodies are buried in financial markets. And no place is more opaque and full of skeletons than private markets. Maybe this is the year we find out what’s in there.
As long as uncertainty exists, there’s no such thing as good or bad debt—only good or bad risk management. This means selecting prudent investments, managing their costs, carefully structuring financing (such as loan types and interest rate risk), hedging and insurance. It sounds obvious, but these considerations are often overlooked, particularly in public finance.
From John Cochrane: Inflation and the Macroeconomy
A one-time fiscal shock gives rise to a one-time rise in the price level. (I owe a lot to George Hall and Tom Sargent, and to Jim Bullard for this analogy.) There is nothing specially fiscal theory in this story. Fiscal theory emphasizes an aspect that is true in all models, however: debt and deficits only cause inflation when people do not expect the new debt to be repaid by higher future surpluses. Debt that will be repaid doesn’t cause inflation.
A one-time unfunded fiscal shock produces a one-time rise in the price level, an inflation surge that can go away on its own. That otherwise puzzling easing is even clearer evidence for this story. Raising interest rates helps bring down inflation more quickly, but at the cost of somewhat more persistent inflation, just as we are seeing.
surely our policy maker’s realization that they did overdo it, and consequence reluctance to take responsibility. They should say “Yes. We faced the pandemic and its aftermath with $9 trillion of vital extra spending. We took most of that out of the pockets of government bond holders with a 20% haircut via inflation rather than raise taxes for a generation. We faced supply and relative demand shocks, and chose to make all prices rise rather than some, and especially wages, decline, which we thought would cause a recession. You’re welcome.” Instead, a dog-ate-my-homework attitude pervades
If we are not proud of this inflation, being honest about what happened is the necessary first step to not repeating it in the next shock..
If businesses could forecast that prices would go up next year, they would raise prices now. Hence inflation will always be somewhat unpredictable.
Tariffs are a corporate tax on imports, partially passed on to consumers. Corporate income taxes are also partially passed on to consumers. You can’t bemoan the inflationary effect of tariffs and deny the same effect of corporate taxes.
Fundamentally, inflation comes from debt we won’t or can’t repay. Long run tax revenue is good for inflation, but that mostly comes from more growth not higher tax rates.
The biggest question for inflation, in my view, is how we will react to the next shock. Bird flu could break out and be much worse than Covid. China could blockade Taiwan, provoking a catastrophic global trade, supply, and financial meltdown. A severe global recession could break out. What happens then? Uncle Sam will come knocking for $10 trillion.
The Fed will be pressured to buy all the new debt again, and hold down rates so the government can borrow cheaply. And Inflation could be the least of our problems. What happens when the US and other governments are unable to raise what they need?
You should read the concluding couple of paragraphs.
Marcus Nunes with a response to Cochrane
I think there is a much simpler and consistent answer. My “guiding light” is the equation of exchange in growth form: m+v=p+y, where m is the growth in money supply, v is velocity growth, p the inflation rate and y the growth of real output. Then, p+y is the growth of nominal aggregate spending or NGDP.
Market Monetarists, on the other hand, assume velocity can change. Therefore, monetary policy should be conducted so as to keep NGDP growth stable. For that to happen, the Fed should strive to vary money supply growth to adequately offset changes in velocity growth.
At the start of the C-19 pandemic, velocity growth tanks, so NGDP falls way below trend, bringin inflation far below target. The Fed, however, reacts quickly, increasing money supply growth to try to offset the fall in velocity growth.
One effect of the big microeconomic shocks was to significantly disrupt relative prices. By February 2021, NGDP had reached the trend path it was on following the Great Recession. Should the Fed have acted to constrain NGDP to remains on that path?
relative price disruptions can be so large that trying to keep NGDP at the stable path that prevailed before the shock can have significant long term negative consequences. Therefore, there may be situations, hopefully rare, when a higher stable path is desirable
“why is inflation stuck at 2.5%”, I feel comfortable to argue that results from putting a large weight on Owners Equivalent Rent (OER), which is an imputed prie, a price that no one pays, and suffers from lagged calculations.
XTOD: Below we see the share of the top 10 and top 50 stocks in the US. A popular narrative making the rounds on Wall Street in recent weeks is that this concentration will lead to a long winter of below-average returns. Much like the CAPE model (which states that high P/E’s lead to lower 10-year returns), a high concentration can diminish future returns. At first glance, that seems plausible, per the chart below. It shows the concentration of the top 50 lagged by 10 years (and fitted to show the suggested return), with the suggestion that the next 10 years will produce below-average returns. If true, a new secular winter is coming fairly soon. However, both the CAPE model and concentration thesis count on mean reversion: that the pendulum will swing the other way. But as the first chart shows, the pendulum doesn’t always swing the other way, at least not right away. Periods of top-heavy concentration can last for decades, as was the case during the 1950’s and 1960’s. The chart above is compelling because it captures the .com bubble, which did indeed mean-revert, but if we take that math back to the 1920’s (below), we see that it’s far from consistent.
XTOD: There is something that I find very perplexing. There was no mention of talking about ending QT in the minutes. Anyone involved in markets is fully aware that QT combined with a heavy issuance calendar is straining GC and causing SOFR spread to FFR to gap. This is now penalising USTs levered longs and feeding into TP. If these liquidity strains are visible to everyone, surely they are visible to the Fed. With the cost of financing for secured longs HIGHER than lending unsecured intrabank held at the Fed, looks like the FOMC is actually looking for a liquidity driven tantrum. Yes reserves are still high but balance sheets are strained.
XTOD: Perhaps one of the GREATEST five-day stretches of football this world has EVER known begins today. Enjoy.
https://x.com/TimmerFidelity/status/1870135320508870747
https://x.com/INArteCarloDoss/status/1877392425112449319
https://x.com/BenScottStevens/status/1877355165545578764
