Two straight quarters of neg GDP (we predicted coming recession)…
At the beginning of this year, we predicted a recession and risk-off period in markets based on the extreme fiscal tightening by the US federal government. While in the US the NBER is the ultimate authority on when recessions start and end, the “rule of thumb” is that two consecutive quarters of negative GDP indicate recession. Some even refer to this as a “technical recession.” While the NBER may very well not categorize the last two quarters as a recession, the fact that we are even having this debate shows the incredible predictive power of the MMT macroeconomic framework: literally no one in the mainstream press or Wall St was predicting recession at the beginning of this year.
Hot jobs report…
That being said, yesterday’s jobs report was undeniably, unmistakably strong, as total non-farm payrolls rose by 528k and unemployment fell to 3.5%, officially matching the pre-COVID era low (although the labor force participation rate ticked lower to 62.1% in July from 62.2% in June).
We are not in a recession yet, but will likely be in the coming months/quarters.
Inflation rolling over…
We’ve experienced relief on the inflation front recently, following the red-hot 9.1% CPI increase in June. Commodities have largely rolled over, and crude oil finished below $90/barrel for the first time since February:
Source: https://www.marketwatch.com/investing/future/crude%20oil%20-%20electronic
5yr/5yr breakevens have come down substantially:
This is not a surprise, because this period was not a “real” inflation. There are essentially two types of inflation: a “real” inflation is when our economy is at true full employment, and additional spending/money creation does not yield enhancements in productivity. We are far from that state of affairs (more on that topic below). The second type of inflation is one related to bottlenecks: we may not be at full employment, but supply side constraints, hoarding, and other bottlenecks are causing prices of goods and services to go up. Once those bottlenecks clear, prices will come down. There is no “secular” change in inflation expectations as many are arguing, and the market largely agrees based on breakevens and an inverted yield curve (which we predicted would happen).
I don’t have data to support, but I suspect there is some merit to the argument that financial markets stress (both in traditional stocks and bonds as well as a frauds like cryptos and NFTs) is forcing people who thought they could make a living off day-trading back into the job market. If true, then this is more of a one-off jobs boost.
Why is consumer sentiment so bad? Taxes remove dollars out of circulation causes fiscal tightening, rate increases force companies to raise prices without expanding output…
Consumer sentiment surveys are at or near historic lows:
Why is it so bad, despite the favorable jobs backdrop? Because consumers are being squeezed: on the one hand, fiscal tightening has caused money to be tight, forcing consumers to go into debt to meet their obligations. Revolving consumer credit balances (e.g. credit card debt) have exploded as of late, after falling substantially during COVID recovery period. This is entirely consistent with the framework of MMT, as federal surpluses are creating household deficits.
Meanwhile, there is no evidence of a “wage price spiral,” as real wages are negative year-on-year. The explanation for this is simple: the Fed’s rate hikes are causing companies to raise prices without expanding output. Think about it: if a large corporation issues commercial paper to meet its short-term funding obligations, and the cost of that debt has gone up thanks to the Fed’s rate hikes, then those companies must raise prices to maintain their margins. Fed rate hikes cause prices to go higher.
Big relief rally in July…
Stocks returned +9%, while HY spreads came in:
YC inversion trade worked…
Our yield curve inversion trade idea has worked:
TLT has outperformed SHY since we posted our idea on May 18, although the spread compressed a fair amount yesterday following the strong jobs report (note, the below shows price comparisons, and doesn’t include dividends reinvested, which would put TLT even further ahead of SHY).
