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If the data suggest price increases are driving inflation, the inflation “debate” ought to center on… prices not wages.  Especially if the data also suggest wages are not driving inflation (very much).  The one thing we should NOT do?  Pretend the world is behaving in line with our pre-baked mental models when the data suggest otherwise…

On that note, lets have a look at wage and price growth over the last few years.

Very tidy chart.  Where is the “wage price spiral” in the above?  Definitely-not-left-wing economists Ben Bernanke and Olivier Blanchard, also don’t see wages as a driver of the recent inflation.  Even though the business press writes as if wages are enemy #1…

While the initial worry was that the main channel would be through tensions in the labor market and resulting wage pressure, most of the movements in headline inflation have come from the goods markets, from price shocks, i.e. large increases in some prices given wages.

Yet we are still served up commentary like this in John Auther’s (Bloomberg) latest piece

The question, she poses, is whether the economy can break inflation in wages — or even the dreaded wage-price spiral — without a incurring a significant increase in job losses? How would that impact consumer confidence? “Yes, job losses have ticked up a little bit, but once people lose their jobs, they can find another job quite quickly,” she said. “And wage gains, though they’ve slowed, have not gotten negative.”

If anything, the chart might argue for a price-wage spiral? Price growth had been… (ahem)… robust.  For example, Pepsi said they had raised prices 15% YoY per their last earnings call.

But a price-wage spiral looks pretty iffy too.  Strip out the big YoY dip in 2021 (echo of the 2020 spike) and wage growth looks pretty flat at 4%.

Admittedly, Blanchard did nod in the direction of a possible future wage-price spiral, writing in May ’23.  But this had a pro forma feel even 2 months ago.  It also hasn’t aged well.

Looking forward, as price shocks are likely to fade, the focus will return to the labor market; wage inflation is too high, reflecting overheating and some increase in expectations. We argue that this requires a substantial decrease in the ratio of vacancies to unemployment

Yet Authers and a recent Economist Opinion piece keep looking for that wage-price spiral.  The Economist ridicules the (admittedly unfortunate) term “greedflation” because, you see, price increases most certainly have NOTHING to do with companies pushing their price envelope under the cover of a crisis.  The Economist, however, gets oddly vague about how else to describe the price data above.  “The first rule of Fight Club is… never talk about Fight Club.”

Another hint at what might have driven recent inflation in this Fed chart:

NB:  The big 2020 spike (and the 2021 echo dip) in earnings “growth” in the wage/price chart above is COVID.  So many low wage workers were laid off that average hourly earnings went way up – only high earners were left in the “average earnings” calculation.  That mostly tells you that ALL the data of the last few years is non-trending and suspect.

In Sunday School Macroeconomics 101, they tell a story about the Fed.

When Uncle Fed cuts rates, it stimulates investment and the economy goes boom!  When Uncle Fed raises rates, investment struggles and the economy goes bust.  So if you just watch Uncle Fed, you don’t need to bother with all those other complicated macro variables.  Isn’t that lovely?

You’ll read versions of this in The Economist, newspapers, investment research, etc. etc.  The Fed drives investment, which drives the economy.  Simple, tidy, obvious…

The story is not, however, supported by actual data on investment – Net, Gross, or Real Investment as a percent of GDP.  I’m not sure exactly what the data below DO say.  But they definitely DO NOT say “the Fed Funds rate clearly drives real economy investment behavior.”  The two other data series at the end give us different charts telling the same non-story.

Net Business Investment as a Percent of GDP (Left Axis) and Effective Fed Funds Rate (Right Axis)

If the Fed were as powerful as many believe, Big shifts in the Fed Funds rates should drive visible shifts in the investment rate.

1. …the last two decades of ever-lower low interest rates should have produced an investment boom. Companies should have been throwing dollars at all sorts of low-return project with rates nearly at zero and Real inflation-adjusted Rates below zero.
2. …the 1980’s, should have seen investment struggle in the face of the Volker’s bold rate rises.  Those huge rate hikes should have sparked a huge fall-off in investment.
3. …the 1990’s should have seen a spike up in investment when rate were were low early in the decade and declining investment as the Fed raised rates later on.

None of these things happened.  These patterns just aren’t there.  Even if you assume all sorts of lag effects, the two trend lines don’t really connect.  If there is any pattern, it would be the Fed Funds rate chasing investment downwards.  Or vice versa…? 

If low rates really drove behavior as much as the Fed fans believe, how do you explain what we DO know.

• The Fed WAS powerless under ZIRP before COVID. That’s why they came up with side show distractions like QE.  The Fed was at the zero lower bound and struggling to re-start the economy.
• A lot of people have forgotten that sluggish, “pushing on a string” pre-COVID economy.  We had a decade of super low rates in the 2010s AND also a decade of super low private capital and public infrastructure investment.
• COVID gave us all a sharp lesson in just how powerful fiscal policy is.  Shocking the economy into higher inflation and super-strong employment after a decade of monetary policy “pushing on a string.”
• Investment today has not, so far, responded to higher rates by going down.  Anecdotally, its been going UP (boosted by Government policy and lot of other  “its complicated” cross-currents.
• Studies showing corporate investment “hurdle rates” don’t change (much) in response to interest rate changes.

I’m not sure how to explain the above myself.  Maybe the free market out there in the real economy is driving real long term rates drives rates more than people want to believe? Maybe the Fed rate and investment aren’t really linked at all?  There are a lot of other drivers out there (e.g. Software isn’t counted as “investment” in these data series).

What we DO  know is “investment” is a lot more complicated than a single number emerging from Washington DC.  So we know we don’t have a simple, one-factor trade…

Faced with the complexity above above, I see/read/hear a lot of people doubling down on simplicity.  If the Fed can’t cause a recession with hikes to 5%, then it dang-gummy must keep raising to 7%!  Because we must have a recession!  Because… why?

Maybe the real impulse is just so “we” can keep clinging to our prior beliefs? Simple rules that comfortably explain a complicated world.  A craving for certainty…

Maybe a recession is the price some think we “must” pay simply to keep our world-view intact?  Doubling down on the same experiment until the results support the belief…

Maybe abandoning that narrative would mean giving up belief in God Santa Claus? Losing the monotheistic comforts of a benevolent Holy Father Fed.  Fearing a polytheistic world of multiple, erratic, uncontrolled Gods indifferent to the petty struggles of humankind.

I’m not sure.  Its complicated…

I try to live in the complicated middle ground between “the Fed is powerless“and “the Fed is a one-factor driver of the economy and all you need to follow.”

That middle ground is neither simple nor tidy nor obvious.   “The Fed is a powerful actor, but not nearly as powerful as some people think.  The real economy runs the show. The Fed is just well-intentioned humans feeling their way along like the rest of us.  Their tools are limited and the effects unclear.  If the data are confounding, they are as stumped as we are.”

I got to that middle ground in the last decade.  The Fed was pretty obviously powerless pre-COVID.  Even The Economist had to admit that.  The last 18 months hammered that relative impotence home.  After 5 points of rate rises we can pretty confidently conclude “the Fed ain’t nearly as powerful as some people wanted to believe in early 2022 or, really, since about 1990 when the “Volker myth” was created (with remarkably little empirical support).”  If the 2010’s didn’t convince you, the last 18 months should have been evidence enough. 

“No-one” expected rates would rise this far.  The few that did were forecasting rapidly rising unemployment and a huge recession.  I certainly didn’t get it right myself.  So the right response is to accept that your prior, simple mental models were wrong.  Take a step back and look at the bigger, more complicated picture.  Even if it doesn’t make tidy sense.

Gross Business Investment as a Percent of GDP (Left Axis) and Effective Fed Funds Rate (Right Axis)

Real Business Investment as a Percent of GDP (Left Axis) and Effective Fed Funds Rate (Right Axis)

Why are so many people howling for a recession?  To quote Bloomberg columnist John Authers…

Bringing inflation to heel is urgent. That could imply that the Fed has no choice but to execute the landing soon — as the alternative would involve zooming ahead and an eventual crash.

But that really the only choice?  A semi-controlled crash now or a [spooky music] “eventual crash” later on?  The lady doth protest too much, methinks…

After 18 months of drama, we have a pretty good handle on what’s behind the headline inflation numbers.

1. Supply shock driven – post-COVID demand and the Ukraine war.  Note that energy prices have gone down a lot lately…
2. Fiscal-policy driven. Fed-fetishizers really hate to admit how powerful those COVID checks proved to be.  As a Real Economy guy, I totally under-estimated them too.
3. NOT particularly wage-driven – real wages are just not galloping ahead.  If you torture the data you can get to a more convenient conclusion, but…
4. At least partly driven by “excess profit” – see the chart link before accusing me of playing politics.  “Excess” means “higher than it usual historical average” – an economics term not a moral or political judgement.  For more, see this paper by Isabella Weber and other economists chiming in on her twitter feed.  She got written up in the New Yorker, but goes oddly unmentioned in the WSJ or FT 🙂

So where are we today?  Does this really solve for “we must engineer a recession as soon as possible!!!!”?  Maybe it solves better for “take a step back and let the free market sort itself out?”

1. Supply shocks are gone (NY Fed).
2. Fiscal policy effects are fading.
3. Real wage growth isn’t ringing alarm bells – at least not in the US.  Wages have gone up a lot for the bottom quartile, but top quartile has seen reduced purchasing power (Atlanta Fed).
4. Profit margins are still high, but that’s not something Fed policy can change directly.  Either you believe the free market will eventually do its work, or the FTC and DoJ are the relevant agencies…
5. Inflation expectations are heading down and look super duper well anchored (Cleveland Fed). 
6. Alternate, pretty clearly more accurate measures of inflation are well out of the Red Zone.  The NY Fed is not a left-wing think tank and 3.5% is not a crisis.
7. Real (Inflation Adjusted) interest rates are positive after a rapid +500bp adjustment.

Could there be another agenda behind all the brave talk of belt-tightening and necessary sacrifice?  Maybe people don’t want to re-price existing assets for a world with rates running in the 3%-5% range.  Today, they are sitting on paper losses.  If this all goes on too long, however, time will convert those into real losses.

To avoid those losses, those people need rates to return (quickly) to the low levels we had pre-COVID in the 2010’s.  The post-GFC era of soggy, deflationary growth.  If it takes a crushing recession to bring those low rates back, that is (for them) the lesser of two evils.  Sluggish growth will cost them less than the mark-to-market losses.

The above may sound “political,” but “politics” is what happens when a social group pursues its own self-interest.  The politics lie in pretending otherwise – hiding a political agenda behind a smokescreen of (remarkably unsupported – really!) econo-babble.  If there is anything “political” here, it is in that deception.

What we do know is this:  Pretty soon the headline inflation numbers and the political calendar are going to make it awkward to press too hard or too loud for a recession.   Per the NY Fed’s clearly-more-realistic-for-the-present-moment data series, 3.5% is not a crisis.  Perhaps that time growing short better explains the urgency some people feel for a bum rush into a recession…?

Note that, last year, I also expected a return to ” slow, deflationary growth.”  I didn’t expect a mega-recession, but I also didn’t expect the Real Economy to be this resilient. Partly because I figured the “get back to low rates” political agenda would prevail.  The real economy thought otherwise…

When the facts change, you should try to change your mind.  So now I’m considering other scenarios.

• Maybe we are going back to the 1990’s (boom years), not the 2010’s (soggy slog)?
• Or, maybe we do get a recession if the yield curve turns out to be right after all?  Although the real economy is not really cooperating so far.

Right now, however, I have no strong views and they are even more lightly held than usual…

This just in:  I’m going to paste in a verbatim quote from the Indeed job site’s analysis of today’s jobs data.  Is 3.5% inflation maybe not so bad if it also gets us this?  And who thinks otherwise?

The US labor market wrapped up the first half of 2023 in a position of strength, and it will take something dramatic happening to derail it anytime soon.

Don’t dismiss job growth of 209,000 per month. Yes, this pace is notably slower than what we’ve seen in recent years. However, given the slowing growth of the US population, we’d need job gains of somewhere between 60,000 and 80,000 per month to keep up with labor force growth. So gains in excess of 200,000 are more than double the pace needed to keep the labor market tight.

The results of this continued strong hiring can be seen in the growth of the prime-age labor force. The share of workers ages 25 to 54 in the labor force rose again to 83.5%, the highest rate since May 2002. Women saw another strong rise over the month, continuing their more rapid post-pandemic bounceback. The participation rate for prime-age women is not only above its 2019 level, but it also set an all-time high for the third straight month.

The sources of the job gains have some surprises in both positive and negative directions. Construction continues to be notably resilient, adding 23,000 jobs in June, with almost half of those gains coming from residential specialty trade contractors. On the flip side, accommodation and food services job gains, a constant source of jobs in the post-pandemic recovery, dropped dramatically to under 5,000 a month, a steep decline from the roughly 60,000 a month on average it added in the year prior.

The labor market is slowing down, but it’s doing so from a position of strength. This report is just another proof point that the labor market is going through a welcome moderation. Demand for workers is high but slowing, and the supply of workers is growing. Nothing is guaranteed, but the US labor market continues to point toward a slower, but more sustainable pace of economic growth.

Who is the “Change” candidate in a Biden vs Trump re-match.?  My gut says neither.

But US voters have pretty reliably voted for “change” since the GFC and Iraq war gutted elite credibility.   So do they force a “change” candidate onto the ballot?  Do they stay home in droves?  Overturn the apple cart in some other way?  I don’t have a good answer.  Just asking the questions…

The twin blows of the Iraq War’s lies and the GFC’s naked self-dealing collapsed elite credibility under George II.  Since then, “Change” has been the best predictor of election outcomes.  The specifics vary by election, but the underlying theme has remained constant.

• Obama in 2008 – the original “change” candidate – bounced Hillary out in the primaries
• Trump in 2016 – Presented with the uniquely unappealing non-choice of Hillary and Jeb Bush, voters grabbed the wheel to (eventually) vote in Trump and (nearly) Bernie Sanders.  People forget just how far and fast that election went off the rails on both sides.
• Biden in 2020 – a bit more complicated, but voters definitely voted for a “change” from Trump.

Democrat:  Biden definitely isn’t the “change” candidate in 2024.  It doesn’t look like we’ll get a real alternative to Biden in the Democratic primaries.

Republican

• Trump was the 2016 “change” candidate, but that fresh feeling is gone.
• Could DeSantis end up the “change” candidate?  Maybe, except that he’s not running on “change” as much as “I’ll be a more ruthless and disciplined version of Trump.” He could escalate the anti-elitism to full-throated “populist class war” levels, but his (highly concentrated) financial backers would yank his funding.
• Could one of the other Republican candidates emerge as the “change” candidate?  That seems more plausible in theory.

But what’s the “change” message that still wins over the MAGA voters?  The best bet likely is “full-throated populist class war…”  But that seems a stretch for most of the people running.  It would definitely send the big dollars back over to Biden.

So how do US voters express that desire for “change?”  The frustration with stale politics is still pretty obviously there.  A Biden v Trump re-match isn’t going to scratch that itch.

Do they go down one level and throw out Congressional incumbents?  Or just stay home?  Or mount a more serious insurrection?

No clue.  But my guess is that frustration will find an outlet somewhere…

I didn’t understand how far the “pro wrestling” rot had spread.  McCarthy delivered what his radical wing wanted.  The wackadoodle’s non-negotiable demand was  a stage on which to go down in glorious, oppositional defeat.  He gave them a stage to strut on; making loud demands; striking defiant poses.   The policy result – universally scored to be a nothing-burger – was totally beside the point.

My worry about the debt ceiling was that MCarthy wouldn’t be able to get “enough” Republican votes to pass a compromise debt ceiling bill.  I was kinda right on that score.

The bill gained 165 votes from Democrats, outnumbering the 149 from members of McCarthy’s own Republican party.

I was wrong to think that McCarthy would not bring a “majority Democrat” bill to the floor.  He did.

I was MUCH MORE wrong to think that his House colleagues would care about the content of the bill.  I assumed they would care about the substance of the policy.  Economist and Historian Brad DeLong puts it well.

Could it be that it was all a game of Dingbat Kabuki? Could it be that what the Republican Rite wanted was for Kevin McCarthy to show that he would push things to the deadlined, and they did not care whether he won substantive policy victories? Was it just McCarthy saying “I will give you a quick and easy substantive budget negotiation if in return you spend two months acting like I am powerful and you are scared”?  https://braddelong.substack.com/p/briefly-noted-for-2023-05-31-we

That vote count is kind’ve encouraging over the next few years.  The US is not a parliamentary system, but we may be entering into an era of coalition government.  If that loose coalition of 165 Democrats and 149 Republicans hangs together, we could move beyond the extreme government dysfunction of the past decade.

The wackadoodle wings of both parties get to do their performative dances in front of the cameras.  The actual business of the nation gets quietly handled by that centrist coalition.  If we have a moderate in the White House (a big if) that cobbled-together system could actually be pretty – functional?

The worrying thing is that Pro Wrestling rot.  This is largely a Republican phenomena.  How far does it spread?  How deep does it go?  Janan Ganesh sums it up nicely in the FT (paywall).

I am no longer sure that populist voters want to win the culture war. Just being in it gives them meaning. If anything, there is more group identity in losing, more solidarity under siege than in triumph. If I am right, none of the governor’s arguments against Trump — his electoral repellence, his boredom with detail — are half as wounding as he hopes.  https://on.ft.com/43s3Equ

The only part he misses are the very worrying strains of Southern (and Western) “Lost Cause” mythology under the surface.  Glorifying “noble defeat” is intertwined with a lot of nastiness in American history…

Nihilism is also just socially toxic.  It eats away at the community feeling that underpins a nation.  In that sense, this coalition government “victory” is just appeasement.  The more we accommodate the madness, the more it will demand.  That is very worrying…

My (wrong) view from a week ago.

In the “Rebel Without a Cause” game of chicken, James Dean jumps.  The other guy’s jacket catches in the door and he plunges to his death (video below).  I think too many people are assuming we are James Dean…

A lot of people have also forgotten what happened the last time a “Grand Bargain” bill got to the House floor (under Boehner and Obama).  Boehner couldn’t corral the votes.  The bill (which read like a 1990’s Republican wish list) died an ugly death at the hands of a fractious Republican caucus.  Ask yourself –  Has the average Republican House member gotten more or less compromise-minded in the last 10 years?

I have no idea where the debt ceiling crazy train ends.  I do see a very narrow path for the widely assumed “moderate compromise” deal ever making it to the House floor for a vote much less passed.

Debt Ceiling – Are We James Dean or Are We the “Other Guy?”

In the “Rebel Without a Cause” game of chicken, James Dean jumps.  The other guy’s jacket catches in the door and he plunges to his death (video below).  I think too many people are assuming we are James Dean…

A lot of people have also forgotten what happened the last time a “Grand Bargain” bill got to the House floor (under Boehner and Obama).  Boehner couldn’t corral the votes.  The bill (which read like a 1990’s Republican wish list) died an ugly death at the hands of a fractious Republican caucus.  Ask yourself –  Has the average Republican House member gotten more or less compromise-minded in the last 10 years?

I have no idea where the debt ceiling crazy train ends.  I do see a very narrow path for the widely assumed “moderate compromise” deal ever making it to the House floor for a vote much less passed.

Lets review the politics how we got here to maybe see where it ends.

1. The Democrats could have just raised the debt ceiling in the Lame Duck session.  They didn’t – possibly fearing it would give Manchin leverage to re-negotiate the IRA.  But they didn’t…
2. I think the (stupid) White House bet was “McCarthy will never get his herd of cats in line to even pass a bill, so we will slide into the deadline with “Republicans in disarray” headlines.  We win politically.  So lets plan for that…“
3. McCarthy actually got a bill passed.  Never mind that was only with this late night caveat (as reported at the time) “please just vote for this its a negotiating tactic it will never become law.“
4. That “compromise” bill has worked as designed.  McCarthy is now engaged in “serious” one on one talks with Biden.  Boosting his image and making the Republicans look competent.  The White house is now on the back foot every time McCarthy stands in front of a microphone and says “Biden isn’t being serious etc etc. “

A lot of people are following that political game and assuming it will end with the White House and McCarthy agreeing some sort of compromise and then that passing the House.

But McCarthy’s current “compromise” bill is too far right to get any Democratic votes or White House approval.  Yet it only got a Republican majority after assurances that it would never become law.

So when McCarthy comes back with a compromise that has moved left, what do you think his chances are for getting a straight majority vote?  It is possible.  But the House Republican caucus has a lot of people who treat the job as full time performance art – like WWE pro wrestling.  They are playing a character on TV.  “Compromise” isn’t in their story arc. 

What are McCarthy’s chances of getting Democratic votes?   That depends on the bill…  There are votes to be had – although there are also fewer Democrats who still quaintly believe their job is to govern.  But the more Democrats that sign on, the more “performative” Republicans will feel compelled to sign off.  Because “compromise” is a dirty word in MAGA politics these days. Compromise is something “weak” Democrats do.

The other dangerous assumption is that Democrats will (or can) keep us from going of the cliff.  Republicans are comforting themselves that (said with a slight sneer) “Biden’s brand is “compromise,” so of course he’ll give it up in the end…”  I think this misses how embattled the Democratic party has become over these years.  The embittered spouse tired of knuckling under “for the sake of the family.”   There are a lot more Democratic House members playing the pro wrestling game these days too…

So how does this all sum up?

1. McCarthy is negotiating to negotiate.  Loving the present moment, but dreading the end game   Because “the guy who needed 14 votes to become Speaker” rightly  fears he can’t actually deliver…
2. The White House has stuck itself.  Biden can’t walk away.  So he keeps negotiating.  Understanding that “negotiations” are the point here, not a “negotiated outcome.”
3. We are watching the performance assuming it all gets tidied up in the end…

We are all partly complicit in how our politics has become pro wrestling.

The risk is that, when it comes time to wrap it all up and jump from the cars, we realize our jacket is caught.  Plunging over a cliff isn’t in James Dean’s story arc, but maybe we are “the other guy” in this script…

<https://youtu.be/BGtEp7zFdrc>

When you have indicators point every which way like this, the “right” answer is…

Don’t put too much weight on any one indicator.  Something is clearly off normal trend.  Guess from the present situation.  Don’t rely on past examples.

But most people don’t look farther than the yield curve, which is definitely predicting a recession.

On the other hand, Labor markets and another “real economy” indicator are showing no reason to worry.

So tread carefully.  Pasting in links below.  Data charts sometimes come in wonky.

The Yield Curve (which is the only thing most investors watch) is screaming “68% chance of a recession.” Although its last “prediction” was really the COVID recession.  I have a lot of trouble believing the bond market foresaw COVD.  But maybe we were fated to have one without COVID?  https://www.newyorkfed.org/research/capital_markets/ycfaq#/interactive

The “Sahm Rule” says “no recession ahead”  This is based on changes in unemployment with an even better track record than the yield curve  https://fred.stlouisfed.org/series/SAHMCURRENT

Nothing showing on the “Smoothed Recession Probabilities” Indicator ” Smoothed recession probabilities for the United States are obtained from a dynamic-factor markov-switching model applied to four monthly coincident variables: non-farm payroll employment, the index of industrial production, real personal income excluding transfer payments, and real manufacturing and trade sales.” https://fred.stlouisfed.org/series/RECPROUSM156N

The current consensus on the Debt Ceiling stand-off seems to be “There will be a lot of noise and drama and then they will pass a compromise and we move on.  Just like has happened in the past.”  I see higher risk the Debt Ceiling game of chicken ends up going off the cliff into a constitutional crisis.

Remember that a Bill doesn’t make it to the House Floor unless the Majority Leader allows it…  Any compromise package that can pass the Senate is going to be “too far left” for a lot of McCarthy’s caucus.  But House Speaker McCarthy will have to actively choose to bring any debt ceiling “compromise” legislation to the floor.

He can only lose 4 votes.  You have to assume that more than 4 Republicans will vote against any deal that could realistically  pass the (Democratic) Senate.  So McCarthy would likely have to bring a bill that passes on Democratic votes.   Does McCarthy have the political capital and courage to do so?

The same dilemma mortally wounded Republican Speaker John Boehner in the Obama years when the Republican House Majority had a lot more moderates…   That would be a tough hand for McCarthy even if he were a strong Speaker.

McCarthy is not a strong Speaker.  It took how many votes to get him elected?  

McCarthy is also not an obvious profile in political courage.  How much did he kowtow to the extremist wing of his party to win that squeaker of a Speaker election?

I also hope to see a compromise, but I’m not so hopeful.  This scenario is predicated on 2 questionable assumptions – especially #2:

1. Are there actually enough D and R “moderates” left to vote a compromise package through?
2. Will McCarthy actually bring a compromise resolution to a vote?

Working from right to left, McCarthy will likely lose one or more Republican vote for every Democratic vote he gains.  So if McCarthy loses more than 4 Republican votes, any bi-partisan compromise bill will have to shift pretty far left.  Even that assumes there is a workable coalition in the center for anything but a straight debt-ceiling raise…

This also presumes any Republican house member is willing to sign up to a compromise.  Look at what happened to the Republicans who voted to impeach Trump after Jan 6th.  Is that a sure bet?  The same calculus applies (less strongly) to House Democrats.

The biggest problem is that McCarthy does not have a way to avoid putting HIS name to that bill.  He knows that risks his speakership and quite possibly his job. Does he take that risk?  Could even the most courageous Speaker conjure a “moderate” majority out of the current congress?

I am hopeful, but I do not like the odds.

Wrote this today, figured I’d share.  A lot of people have been comfortably riding a “mega recession ahead!!!” macro call for 18 months now. The sell-by date on that bet is coming soon.

If that “big recession, big spike in unemployment” bet does not pay off soon, it might stop being a self-fulfilling prophecy. 2H spending un-freezes at some (decent) level. The Fed eases up (saving the banks). We learn to live with 3%-4% inflation. Remember, the 1990’s weren’t all that awful (see Thought Experiment 1 below).

Yes, Economic data keep pointing to a slowdown. No, the data are are not (yet) saying “mega-crash in the next 3-6 months.”

What if things don’t crash soon? How long can the Fed hold rates here? If the yield curve stays inverted too long, it risks driving the banking system and a lot of Commercial Real estate off a cliff… The Fed has been hoping employment would fall off before it un-inverting the curve.

The current market bet (right now) seems to be that the Fed will jump out first in this game of chicken. Cutting rates sooner vs later and flattening the curve. The market bet may change. We might go off the cliff.

Please don’t staple a “no recession” forecast to my forehead. Credit is tight and getting tighter. That will definitely add to the slowdown we already see. We are definitely slowing down. The data show that.  I am just noting that “slowdown” might not be enough deceleration fast enough for the assumed Fed game plan.

We’ve had 18 months for rates – raised far higher than anyone expected – to do their work. We mostly have a banking crisis to show for it Maybe macro gets really really ugly in the next 3-6 months? But if it doesn’t?

• Thought experiment 1 – no-one remembers the 1970’s inflation era (scary music here), but not many people remember the 1990’s either (happy boom times music here). You wake up in 1995. PCE inflation is ~4% – heading downwards with forward expectations are well-anchored. Unemployment is below 4%. We are on the verge of a massive AI-driven technology innovation wave. Would the market be feeling depressed/worried? Or would markets be pretty happy?

• Thought experiment 2 – If inflation is at 4% and trending down (or the long-term surveys and TIPS aren’t trending it up), will the Fed have the political cover to keep pressing? A steeply inverted nominal yield curve is already threatening a banking and Real Estate crisis. Is the Fed really willing to risk that?

The block in the mental model is the Fed’s 2% inflation target. That target is hardly written in stone. It is only 10-11 years old. It led to 1% trend inflation in practice. We spent the 2010’s fighting deflation…

• 2% has been in place since… 2012.

• There is no formal academic support for 2%. It was basically pulled out a hat on a talk radio show in New Zealand.

• We’ve realized a 2% “target” ended up a de-facto ceiling. So trend inflation ended up at 1% trend (too low). Goodharts Law (see below)

• If we set the formal target at 3%, it would be the new de facto ceiling. Trend inflation would likely be around… 2%! That doesn’t sound too awful.

The political problem is how to you drop the 2% target and go to 3% without embarrassment? No clue. Probably just talk a lot about 2%, but let everyone know that’s not so serious anymore. Maybe use the debt ceiling crisis as cover to cut rates? But that does seems a better option than a crisis.

Goodharts Law strikes again:

Goodhart’s law is an adage often stated as, “When a measure becomes a target, it ceases to be a good measure”.[1] It is named after British economist Charles Goodhart, who is credited with expressing the core idea of the adage in a 1975 article on monetary policy in the United Kingdom:[2]

Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.[3]

It was used to criticize the British Thatcher government for trying to conduct monetary policy on the basis of targets for broad and narrow money,[4] but the law reflects a much more general phenomenon.[5]

A friend – probably sick of hearing about inflation – actually (gasp) asked for an update on Ukraine.  So here goes.

The last few 3 months would seem to support the “stalemate” view of the war.  Except for one minor detail.  The Russians have actually been pushing an offensive with pretty much everything they’ve got.  They just don’t got very much left…

You don’t have to be a military expert to conclude that the attacking side is in deep doo-doo when a “big push” offensive is indistinguishable from “stalemate.”  The Russians have fought themselves to an exhausted standstill.

Ukraine is preparing its own offensive.  With luck, they will punch through somewhere.  If they do, they have a pretty good shot at precipitating a rout – see “exhausted standstill.”  Will Ukraine get a breakthrough?  Napoleon (apocryphally) gives us the most honest answer.

I would rather have a general who was lucky than one who was good. – Napoleon Bonaparte

Watch for a sharp shock campaign of farther-behind-the-lines strikes.  Followed by a big push in the place(s) Ukraine thinks the Russians are weakest.  What specific territory they capture doesn’t matter nearly as much as getting far enough behind enough Russians to spark a rout.  The target is the Russian Army itself, not the geography.

Ukraine does bring a lot to make its own luck.  They…

• …can choose time and place.
• …have a HUGE number of freshly trained (albeit green) troops.  The units getting exhausted fighting Russia to a standstill around Bahkmut don’t need to carry an attack.
• … have brand new Western hardware.  A lot of this equipment is massively advantaged vs the Soviet-era gear the Russians (barely) have.  Russia is now bringing T-55 tanks (built in the 1950’s) to the front because they ran out of 1960’s era T-62’s…  Those things are all one-shot deathtraps for their poor crews.

Most importantly, Ukraine probably have a “secret” stock of longer-range missiles, bombs, and drones than can seriously disrupt Russian supply and command points.  They already did this did this out to a certain range with the HIMARS missiles.  With longer-range weapons, they can blast a whole bunch of new targets.  The way supply chain networks work, even small lengthening of the individual web links sums up to major reduction in total carrying capacity.

So if Ukraine’s luck holds, we could be looking at the War ending (in fact if not officially) in the next few months.  That would be a good thing for markets, the economy, and the world.

What if luck doesn’t show up?  What if Ukraine…

• …doesn’t break through?
• …does break through, but the Russians miraculously re-group and hold?

…then we might be facing a stalemate.

Ukraine will still have “won.”  If they don’t backslide into cronyism, they have won a place in modern, prosperous Europe.  They won’t be a Russian satellite.

Russia will still have lost.  It has destroyed  the weapons stockpiles it inherited from the Soviet Union.  Modern-day Russia doesn’t have the economic capacity to replace it all.  It will take ages to replace what little it can.  Putin is probably dead or near-dead before that happens.

But it would be really nice if Ukraine won big.  Because then Putin and all he stands for will lose big.  The Chinese lose big.  And that is, ultimately, hopefully a good outcome for the US and the world.