Fear the vibe shift: growls of recession?

My morning began with an article from NPR:

**Fear The Vibe Shift: Are We Entering A Recession?**

**NPR Planet Money, May 31, 202210:34 AM ET**

**by Greg Rosalsky**

**Despite all the talk about the U.S. entering another recession, the unemployment rate of 3.6% remains historically low, job growth remains strong, and, notwithstanding inflation, consumer spending continues to be like a firehose. That said, the U.S. economy shrank by an annualized rate of 1.4 percent in the first quarter of 2022 [due to inventory adjustments], which means we may already be well on our way to the technical definition of a recession, albeit maybe a teeny-tiny one...**

**Bad things happening in the world can lead to a dark turn in animal spirits. In modern parlance, you might call it a "vibe shift." Fear and pessimism, bad vibes if you will, can become contagious. ...Earlier this month, the University of Michigan's gauge of consumer sentiment fell to its lowest level in more than a decade. The trend in gloomier animal spirits is one sign that a recession is stampeding towards us. ...** [end quote]


Recessions are declared by the NEBR after the recession, which doesn’t help us a lot. We want to know if we are hearing growls of impending recession now.


Treasury yield curve inversion - the yield curve is currently slightly inverted in a couple of places. If the Federal Reserve raises the fed funds rate to 2.5% or 3% (or even higher if inflation doesn’t recede) the Yield Curve would become definitely inverted. Historically, recession usually follows 6 to 12 months after a yield curve inversion.


Conference Board’s Leading Economic Index
The ten components of The Conference Board Leading Economic Index® for the U.S. include: Average weekly hours in manufacturing; Average weekly initial claims for unemployment insurance; Manufacturers’ new orders for consumer goods and materials; ISM® Index of New Orders; Manufacturers’ new orders for nondefense capital goods excluding aircraft orders; Building permits for new private housing units; S&P 500® Index of Stock Prices; Leading Credit Index™; Interest rate spread (10-year Treasury bonds less federal funds rate); Average consumer expectations for business conditions.


**Federal Reserve’s Portfolio Runoff Has Begun**
**Central bank is allowing securities to exit from its $8.9 trillion portfolio by not reinvesting the proceeds when they mature**
**By Nick Timiraos, The Wall Street Journal, June 2, 2022**

**The Federal Reserve began the process Wednesday of shrinking its $8.9 trillion asset portfolio. Starting June 1, the Fed will allow up to $30 billion in Treasurys and $17.5 billion in mortgage bonds to mature every month without investing the proceeds. The central bank is shrinking its holdings passively, or by attrition. (Because none of the Fed’s Treasury holdings mature until June 15, this process for Treasurys doesn’t actually take effect for two more weeks). In September, the Fed will allow twice as many securities — $60 billion in Treasurys and $35 billion in mortgage bonds — ...to run off its portfolio....**

**The Fed essentially created money out of thin air to buy the bonds. Now, it will destroy the money in the same way. When the Fed purchases a security, it creates a bank deposit known as a reserve that shows up in the account of the seller. When the process is reversed, instead of reinvesting the proceeds of maturing bonds, the Fed erases them electronically. It doesn’t print currency to purchase the bonds, and so it won’t be destroying any paper currency. The electronic money essentially vanishes from the financial system....**

**In a February speech, Fed governor Christopher Waller said he thought reserves as a share of gross domestic product — around $3.8 trillion or 16% of GDP at the end of March — could potentially decline to levels seen in early 2019, when they were around 8% of GDP....allowing Treasury and mortgage holdings to decline to around $6 trillion in mid-2025....** [end quote]

Quantitative Easing (QE) by the Fed was a process of the Fed creating money out of thin air.

The Fed created a massive amount of money that was invested in assets, lifting the prices of stocks, bonds and real estate. The Fed’s money pumping is the reason stocks and bonds became correlated even though they historically moved opposite each other. $9 Trillion (38% of GDP) created out of thin air bidding against YOUR hard-earned dollars for asset prices. No wonder the prices soared! (And you thought it was because you were such a brilliant investor?)


Quantitative Tightening (QT) by the Fed destroys the money. That’s why stocks and bond prices are falling together. If the Fed executes the plan of major QT until 2025, the suction of free cash out of the system will be a big headwind for the prices of stocks and bonds and will continue to force mortgage rates higher.

The Fed’s plan to control inflation by raising the Fed funds rate and longer-term yields by gradually eliminating their massive book of bonds will slow the economy. Evaporating money will inevitably lower asset prices.

This is certainly a trend change.

Will it cause a recession? Economic writers are trying to sense the vibe. It’s not a sure thing.



Call it a dollar buy back. The greenback is appreciating for some time to come.

As Russia undercuts OPEC oil will drop.

Commodities in general will drop in terms of the USD.

Will it cause a recession? Economic writers are trying to sense the vibe. It’s not a sure thing.

I have changed my outlook. I expected inflation to be a temporary thing, one fairly large whoosh, followed by a slump back to normal. Given the continuing Covid variants and lockdowns in various parts of the world, oil shortages because of Ukraine, and other factors I see production shortages and continuing supply chain issues, which I believe are the primary short term causes of the inflation we’re seeing.

Added to that, of course, was the helicopter money, which has now stopped. So increasing demand chasing diminishing supply has eased … or has it? The supply will continue to be disrupted, and in the interconnected world we’ve built over the past 20 years we will see echoes, perhaps for several years until sourcing can be localized better, Covid variants become normal, and kinks in transport are worked through. Oil pricing is always a crap shoot, but those increases show up everywhere: production, transportation, leisure, etc.

All of that said, I don’t see cataclysm, in fact if the 70’s were known for stagflation, my guess is that we’re going to see the opposite, or a “growth recession.” In that supplies remain tight, unemployment stays low, jobs still go begging, but a recession happens on a technicality, that is, the gross (macro) numbers wobble while the effects are discontinuous: we import less (so there is unemployment at foreign suppliers), we shift back to services, and more jobs are lost than created (because service industries tend to pay badly and boomers continue to be fed up and retire.)

What I see is not a scenario for great pain, except in inflation which is widespread, affects virtually everyone, and has the propensity to 1) become embedded, 2) hurt the party in power, and 3) create expectations for the near future.

We have had what were called growth recessions before, in the 60’s and the 90’s, and stocks did OK. I don’t believe they were as overpriced then as now, so I’m not predicting anything, just noting that in a growth recession (as opposed to a full bore recession) it’s not necessary a bad time for stocks. Batten down the hatches, maybe, look at high flyers certainly, but overall, well, who knows?