ACTV - Still No Boom No Bust
2023-09-15 22:55:00 ET
Summary
- Back in July I ran a post titled "No boom, no bust." Things haven't changed much since then: inflation has come back down to earth, and the economy continues to grow, albeit slowly.
- Stocks are up a bit, the Fed tightened once, credit spreads have tightened a bit, and the market continues to worry that another Fed tightening might be the kiss of death for the economy.
- The Vix index is back down to pre-Covid levels, and stocks have been rising - though not yet to new highs.
Back in July, I ran a post titled " No boom, no bust ." Things haven't changed much since then: inflation has come back down to earth, and the economy continues to grow, albeit slowly.
Stocks are up a bit, the Fed tightened once, credit spreads have tightened a bit, and the market continues to worry that another Fed tightening might be the kiss of death for the economy.
Chart #1
Chart #1 compares the level of the S&P 500 to the level of the Vix "fear" index. The two tend to move in opposite directions: rising fear levels result in lower stock prices, and vice versa. The Vix index is back down to pre-Covid levels, and stocks have been rising - though not yet to new highs.
Chart #2
Chart #2 shows Bloomberg's Financial Conditions Index, a reliable measure of the underlying health of the financial markets and thus a forward-looking indicator of the health of the economy. Conditions are about average these days, so it's reasonable to expect the economy will continue to grow, albeit slowly (~2%).
Chart #3
Chart #3 compares industrial production levels in the U.S. and the Eurozone. There has been very little progress in the level of industrial production since 2007, although the U.S. economy has been somewhat more dynamic than the Eurozone economy by this measure. Still, nobody's posting gangbuster numbers.
Chart #4
Chart #4 shows U.S. manufacturing production, a subset of overall industrial production. Here again we see very little improvement in recent decades. Ho-hum. But neither do we see any deterioration.
Chart #5
Chart #5 shows two measures of producer price inflation at the final demand level. This captures inflation at an earlier stage of the inflation pipeline than the CPI. By either measure, inflation has fallen to less than 2%.
The Fed's done. The CPI won't be far behind, except for the fact that energy prices have spiked of late - through no fault of the Fed's. Biden's Green agenda is at work here, as well as fallout from the Ukraine-Russia war.
Chart #6
Chart #6 shows two broader measures of inflation at the wholesale level (as of August). Here again we see inflation back down to where it should be: 2% or less.
Chart #7
Chart #7 shows the 6-month annualized rate of change of the CPI compared to the CPI less shelter costs. As I and many others have been pointing out for the past several months, shelter costs have been artificially inflated as a result of the BLS using backward-looking statistics related to housing prices.
Chart #8
Chart #9
The major component of shelter costs used in the CPI comes from what is called Owner's Equivalent Rent. As Chart #9 shows, OER is driven primarily by housing prices 18 months in the past.
The chart shifts OER to the left by 18 months to correct for this. Here we see the peak in housing price inflation corresponding to the peak in OER. Since housing prices peaked over a year ago, OER is now beginning to decelerate.
That deceleration is showing up very clearly in Chart #8, which looks at changes in the level of OER over 1- and 3-month annualized rates. What this means is the OER is going to be contributing meaningfully to lower rates of CPI inflation in coming months.
The FOMC meets next week, and I see no reason for them to raise rates yet again. The big question is when they will begin to lower rates. Today, the market is betting on a 30% chance of another rate hike at the November meeting, with rate cuts not likely until mid-2024.
It's important to note (again) that Fed tightening this time around is fundamentally different from tightening cycles in the past. The main difference this time is that the Fed is not draining reserves from the banking system. Reserves are still plentiful at over $3 trillion. That's a huge deal.
Chart #2 makes the point another way: there is no shortage of liquidity in the financial markets, unlike during periods leading up to recessions in the past. The only thing that is "disturbing" the economy this time around is that short-term interest rates are relatively high.
That doesn't necessarily pose a threat to the economy. It simply makes it more attractive for people to hold money - that is, higher rates increase the public's demand for money, and that in turn neutralizes the amount of "excess" M2 that is still circulating. See this post from late August for a more detailed explanation.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Still No Boom, No Bust