Control Panel: Macro trends continuing

Investment Analysis Clubs Macro Economic Trends and Risks
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The main Macro trends affecting our investments are the economy, the Federal Reserve’s actions and the response of the asset market investors.

In December, the Consumer Price Index for All Urban Consumers increased 0.3 percent, seasonally adjusted, and rose 3.4 percent over the last 12 months, not seasonally adjusted. The index for all items less food and energy increased 0.3 percent in December (SA); up 3.9 percent over the year (NSA).
https://www.bls.gov/cpi/

The CPI affects returns from inflation-adjusted securities (TIPS, I-Bonds). The Fed pays more attention to the PCE index.

It Won’t Be a Recession—It Will Just Feel Like One

Economists, in survey, pare back probability of recession in 2024, but still see anemic growth and rising unemployment

By Harriet Torry and Anthony DeBarros, The Wall Street Journal, Jan. 14, 2024

The good news is the probability of a recession is down sharply, according to The Wall Street Journal’s latest survey of economists. The bad news is that, for a lot of people, it is still going to feel like a recession…

Economists on average expect the economy to grow just 1% in 2024, about half its normal long-run rate, and a significant slowing from an estimated 2.6% in 2023…Cyclical sectors — those most sensitive to the economy’s ups and downs — are likely to struggle in 2024, even if there isn’t an overall economic contraction… [end quote]

The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the fourth quarter of 2023 was 2.2 percent on January 10. A slowing to 1% would impact profits which would show up in subsequent quarters.

The stock market continues its strong bullish trend from 2023. The CAPE shows that it’s still in a bubble. The Fear & Greed Index is in Greed. The trade is risk-on, as stocks and junk bonds are rising faster than bond prices. Margin, which correlates closely with the SPX, fell between July and October 2023 but rose in November. The December number isn’t published yet. A rise in margin would be bullish.

The bond market is in a bullish trend, as bond prices rise while the yield falls. The Treasury yield curve has dropped. The 2-year T-bill yield is a full percent lower than the 3-month, which is an unusually large spread. The 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity is strongly negative. In the past, this predicted recession but the situation is different now with the Fed pinning the fed funds rate to combat inflation.

The METAR for next week is sunny. The bullish trends are continuing with the usual noise. The METAR is a short-term prediction which will change when the economy changes.

Wendy

https://www.cnn.com/markets/fear-and-greed

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That yield curve looks ugly and inversions have been reliable recession indicators https://www.ustreasuryyieldcurve.com/.

From the Chicago Fed:

A related explanation is that market participants might expect that aggressive monetary policy tightening by the FOMC, which would push up current rates relative to future ones, heightens the odds of a future decline in economic activity. To the degree the market’s forecast of a downturn is correct, such moves in the yield-curve slope will be associated with a higher probability of a future recession.

The Fed seems still eager to take the punch bowl away:

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So what is the rationale for optimism -
DC‘s ample fiscal stimulus?

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@SuisseBear I agree with you. The Fed is taking the punch bowl away gradually. The Fed has stated that they want a neutral monetary policy that will not stimulate (or slow) the economy.

The fiscal stimulus from the federal deficit has declined as a percent of GDP relative to the Covid stimulus years. But the deficit is rising.

Just one quarter into fiscal 2024, the federal government has already run a budget deficit of over half a trillion dollars.

The December budget shortfall came in at $129.37 billion, according to the latest Monthly Treasury Statement. That drove the 2024 deficit to $509.94 billion. That’s a 21 percent increase over the first quarter deficit in fiscal 2023.

This follows on the heels of the third-largest annual budget deficit in history (1.7 trillion).

These massive monthly budget shortfalls are pushing the national debt higher at a dizzying pace. [end quote]

But I think that the market bullishness is pure speculative frenzy from investors who are springing back from the 2022 bear market in hopes that the Fed will stimulate again. It’s a bubble market with very high P/E multiples.

That’s why I keep repeating that the METAR is a short-term forecast. Speculative bubbles have burst many times before. The market is way ahead of the Fed’s intention in terms of interest rates in 2024.

Wendy

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Suissebear (good to see you!) and Wendy’s reply eclipsed her (excellent as usual) main data METAR post. Very interesting and to the main point.

d fb

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Seasonality? These are news headlines during this earnings season.

https://www.google.com/search?sca_esv=598472506&rlz=1C1RXQR_enUS1062US1062&q=earnings+outlook&tbm=nws&source=lnms&sa=X&sqi=2&ved=2ahUKEwiR-Yi4td6DAxVNM1kFHWsVDS4Q0pQJegQIExAB&biw=2560&bih=1271&dpr=1.5

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The labor market. As long as people have jobs they continue to spend.

DB2

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I sometimes worry that credit demand will be the cause of the next recession. But that’s because I can’t see where all the money is coming from. I see the treasury refinancing about $7-8T of debt this year, all at higher rates than previously, I also see them refinancing ALL the interest accrued of that debt, and I see them financing another few trillion of new debt. And all of it at higher rates than seen in a few years. And, of course, the Fed is shedding about $90B a month adding to the above numbers.

So where is all that money coming from exactly? Each and every one of those treasury bills/notes/bonds are purchased by someone. Where exactly does all that money come from? And, more importantly, is it starving out other things in the productive economy that might better be financed? And if those other things don’t get financed, are we seeing lower growth due to that lack of capital available for them?

I mean, we worry about CRE because it has to refinance ~$150B this year (and another ~$400B in '25/'26) at higher rates, but that is a pittance compared to the numbers the Treasury is doing every month!

[Added section]

I’ve seen a few folks here say that strong economic growth will eclipse all the debt over the next few years, but has anyone actually run the numbers to see exactly how much economic growth is required to do so? I figure, very roughly, $34T of existing debt, let’s say an average of 3% interest, and let’s say $1.5T of new debt (excess spending over revenue) each year. So new debt = 3% x $34T + 1.5T = $2.5T total new debt. And let’s say GDP is $27T. So using simple numbers, just to cover that new debt, the GDP has to grow by 2.5T/27T = 9%.

So, what if we assume interest rates drop dramatically over the next 18-24 months, and let’s say the average treasury debt goes down to a 2% rate. New debt from interest = 2% x $34T = 680B. And let’s say that the new debt each year rapidly decelerates to $720B. Total new debt is now only $1.5T. Growth required to cover that is 1.5T/27T = 5.5%.

Are there any credible estimates of sustained growth in the range of 5.5-9%? And remember that’s just to cover the new debt part of the economy, not to cover any real economic improvement. You would need additional economic growth over and above these numbers to do so.

Sorry folks, I’m an engineer and I always like “running the numbers” to challenge our assumptions.

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@MarkR thank you for your excellent post which is worth 10 of most ordinary rec’d posts.

Before the Federal Reserve began its massive purchases of Treasury debt with money created electronically (“out of thin air”) – QE – so-called “bond vigilantes” would force interest rates higher as supply of debt began to pressure demand for investing in that debt.

Governments throughout history have tried to finance their debts by degrading the currency. (cf. “This Time is Different,” by Reinhart and Rogoff) The result is eventual collapse of the currency.

The Fed is backing away from that well-known disaster by gradually reducing its purchases of Treasuries and mortgage debt.

So, as you wrote, where will the money come from to buy the increasing waves of debt?

The recent drop in the key 10-year Treasury yield is beginning to reverse.

The historic yield of the 10YT pre-QE averaged inflation + 2.5%. So, even if inflation drops to 2% the floor for the 10YT yield should be 4.5% – assuming that the Fed will follow through on their declared plan to back out of buying Treasuries.

As you wrote, there aren’t any credible forecasts of sustainable, non-inflationary 5% growth in the economy. Between 1980 and 1995, the rate of growth consistent with a steady unemployment rate was about 2.4%.

Wendy

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Sure, because economists were so spot on predicting the recession of 2022. And 2023. And the anemic growth that turned out to be 5% in the latest quarter. Somehow these economists have turned out to be like blind weathermen locked in a closet without instruments, but still issuing predictions about the big storm heading our way.

The money, for the most part, is coming from - and going to - investors, who tend to keep it in motion. Not all of it obviously, but a fair amount goes into investments in AI, battery technology, and other things now clamoring for it. Some goes into the market, inflating assets - some beyond what others would consider “fair value.” Some just sits in bank accounts, giving the banks something to lend to others and still maintain their ratios. Some is in consumer hands and bush’s swanky new pocketbooks from Hermes. Money in motion isn’t all “new”, it’s just recycled faster.

I don’t think so, the law of large numbers is devilishly hard to beat. That said, you can get a quick hit here or there, especially if there is some major technological breakthrough to induce demand, and if the economy is percolating to give everyone a sense of well being.

Except when it’s not, like when the government built the Interstate Highway System and goosed productivity nationwide.

  • Or when the government subsidized space travel and the development of microchips and processors and presaged a technological revolution we are still enjoying.
  • Or when they built the Erie Canal, which simultaneously deflated food prices along the East Coast while pushing development to the Mid-West.
  • Or when they bought Alaska.
  • Or the Louisiana Purchase.
  • Or paid for the development of the Transcontinental Railroad.
  • Or when they bailed out the banks in 2008 and halted a sure national economic collapse.
  • Or built Hoover Dam, or the Panama Canal.
  • Or developed nuclear technology before anyone else in the world.
  • Or funded the GI Bill, vastly improving the human capital of the country.
  • Or, speaking of, the Marshall Plan, which accelerated the recovery of Europe immeasurably, giving peace and prosperity to a valued partner.
  • Should I mention DARPA?
  • Or perhaps the human genome project?

All of these “debts” turned into vast improvements in the economy, in livelihoods, and in the quality of life.

There’s lots more, of course. Just as a corporation needs to borrow to build a new factory or make production more efficient or invent new products, and just as a person needs to borrow to buy a house or a car to improve their life, governments need to borrow to improve the lives of the populace. Sometimes those investments don’t work out (all three categories, above) and sometimes they are ill considered, but no, borrowing doesn’t inevitably lead to chaos, destruction, and the end of times as the borrowing scrooges would have you believe.

Based on results, borrowing is pretty much a great thing, used appropriately. Also based on results, it has worked out pretty well.

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I believe Wendy is correct in general, just that maybe 2024 is not necessarily the year that a recession with happen. Or 2025, or 2026 for that matter. But it will happen as some point, I’m convinced.

Pete

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This is literally the crux of my query. Back then the government took 1% of the GDP growth for some number of years (to create the interstate highway system) and it created additional growth of 3+% in GDP growth. Now the government is taking 5.5% to 9% of GDP growth each year for the foreseeable future, and I’m asking what you think it will produce? It’s a simple math question. The new growth could comprise AI, could be autonomous vehicles, could be all sorts of alternative energy sources, could be new lifesaving tech, space exploration, etc, but the question is - in the aggregate how much GDP growth do you think it’ll all provide over time? Like I said, I’m an engineer, and I like to see the numbers.

And recession or no recession has little bearing on these particular numbers, other than perhaps slightly raising the range of 5.5-9% as necessary to stimulate economic growth with government spending to get out of recession more quickly.

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The value of this type of information is not necessarily knowing that something will happen, but knowing when it will happen.

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Yes, exactly. That was my point, inelegantly as it was made. The Yellowstone caldera will, from all thermogeological evidence, erupt at some point. Whether that eruption takes place this year or in 600,000 years makes a great difference for those of us living now.

Pete

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Almost 2/3 of government spending is mandatory – Social Security, Medicare, unemployment insurance. This will boost GDP in the sense that the money will be spent on goods and services. But it won’t increase productivity the way the interstate highway system did.

Wendy

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Mark,

You are not running the tax receipts based on stronger growth. Wages have all increased. So have the tax receipts. Corporate growth greater tax receipts.

CRE has problems. That is not major to the economy. Great feel good story for those in PJs doing office work. Poke in the eye to the bankers.

The economy is being optimized. Over the decades to come the debt to GDP ratio will decline. The debt will rise. The debt rising is commonplace in any well-taught public finance class.

In a lifetime the public finances grow in a staggering way. No prior decade compares to the current decade. That is why inflation scares people. Growth with low inflation should inspire people.

Worth discussing no private sector activity happens without the public sector. It is makebelieve that some mighty company is totally without need of Uncle Sam. The economic system must be optimized. That is the debt-to-GDP growth ratio failure of 1981 to 2020.

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Don’t think so.

There are only three solutions that I can see and unfortunately all are politically untenable.

First, significantly increase immigration and thereby expand the workforce relative to retirees. This could hopefully be done without suppressing wages too much.

Second, some combination of raising taxes and reducing benefits. Obvious but heartless. I suspect people are going to have to work to an older age before receiving full retirement.

Third, social engineering to significantly reduce health care costs. This would include raising revenue through higher deductibles for the overweight/obese and higher taxes on the primary causes of obesity (fast foods, corn syrup, etc). Again, heartless, but health care costs will continue to increase as the population gets older and fatter. One or the other needs to be controlled.

Some combination of these three might be enough to control the national debt.

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@btresist now that obesity has been re-defined as a disease that would be illegal. Violates the Americans with Disabilitites Act.

In the early 1990s, Oregon developed a sensible plan for keeping health care costs within the state’s budget.

A team of doctors developed a list of medical treatments on the basis of cost/ benefit. At the top of the list was vaccination which had a huge payoff for minimal cost. At the bottom of the list were expensive treatments for rare conditions.

President George H.W. Bush had the federal government sue Oregon on the basis that the program violated the Americans with Disabilitites Act since certain patients were excluded from state-reimbursed treatment on the basis of their rare diseases. Oregon was forced to scrap the program.

“higher taxes on the primary causes of obesity (fast foods, corn syrup, etc).”
This is already being done in localities that tax soda. It is legal and it works.

Wendy

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Of course I am accounting for increased tax receipts! They come from the expansion of GDP.

I’m not sure you understand, but this literally says that GDP will rise at a faster rate than debt will. Therefore you are saying that GDP will rise more than 5.5%-9% in the coming years.

Whenever we have these discussions, there’s a lot of talk, but nobody is willing to put numbers to their talk. How MUCH additional taxes do you think will be collected? How MUCH would increased immigration contribute to GDP while not contributing to debt? The other thing that is consistently glossed over is that the system is a closed system, and moving around money from one segment to another segment within the system doesn’t really affect the overall numbers for this kind of calculation. The only thing that can affect this particular thing is if growth of the economy can outpace growth of the debt.

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No, I am saying the tax receipts will rise faster than the yearly deficit.

CT has a surplus because we have over 4000 manufacturers in this state.

The doughnut store example is a small producer of a product with a store team to sell the product.

Each time a donut goes up a nickel and coffee goes up a dime the store owner can pay the counter help and baker an extra dollar per hour while he pockets $2 more per hour as the owner. Inflation being less than 5% on the doughnut and less than 3% on the coffee. These are luxury goods so that is okay.

Meanwhile, two things happen with economies of scale. First, our store owner’s utilities become less inflationary because energy supplies are negotiated better by the bigger factories meaning energy production stabilizes and plants are paid for more quickly with onshoring. Second economies of scale mean activity grows so demand for doughnuts grows.

Taxes go down with some political pressure to make the middle class wealthier because that pays for the local factories quicker as demand rises.

This has proven out after WW II.

The chart’s blue area is based on the failure of supply-side economics. Instead we are in demand-side economics again.

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