{"id":64405,"date":"2023-09-22T23:53:18","date_gmt":"2023-09-23T03:53:18","guid":{"rendered":"https:\/\/ifintechworld.com\/markets\/higher-for-longer-will-suffer-the-same-fate-as-transitory\/"},"modified":"2023-09-22T23:53:22","modified_gmt":"2023-09-23T03:53:22","slug":"higher-for-longer-will-suffer-the-same-fate-as-transitory","status":"publish","type":"post","link":"https:\/\/ifintechworld.com\/?p=64405","title":{"rendered":"\u201cHigher For Longer\u201d Will Suffer The Same Fate As \u201cTransitory\u201d"},"content":{"rendered":"
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As expected, the Fed \u201cpaused\u201d at its September meetings. And while the Fed\u2019s administered rates did not change, the markets interpreted this as a \u201chawkish\u201d pause, and market rates across the spectrum rose in the aftermath of the Fed statement and the Powell press conference. The \u201chawkishness\u201d can be seen in the dot-plot chart. The gray dots are the views of the 19 FOMC members as of June for the end of 2023, 2024, 2025 and long-term. The yellow dots are as of the September meeting. The gray line is the median view as of June, the green line as of September. The dot-plot clearly shows the \u201chigher for longer\u201d mantra.<\/p>\n

While the forecast for Headline CPI remained the same as in June, the justification for \u201chigher for longer\u201d interest rates was the upward revisions to the Fed\u2019s GDP forecasts, both for the remainder of this year and for 2024. Powell attributed the upward revisions to \u201cstrength in consumer spending.\u201d (Readers of this blog know that we have a different view of consumer strength \u2013 more on that below).<\/p>\n

The range in the dot-plot is also interesting. For the end of 2024, the range is from 4.5% to 6.25%. There is no Recession penned in. For the end of 2025, however, the range is 2.75% to 5.75%. And, clearly, a few of the FOMC members see a Recession forming over the next couple of years. It appears that the strength Powell sees in consumer spending is the result of looking through the rear-view mirror, at past data. He doesn\u2019t see the exhaustion of the \u201cexcess savings\u201d (i.e., the free money from 2021 and 2022) and clearly isn\u2019t considering the restart of student loan debt repayments in October.<\/p>\n

Our view is that emerging economic weakness has already appeared, it is just starting in the U.S., but is clearly underway both in Europe and China, and is just emerging in Japan.<\/p>\n

Controlling Market Sentiment<\/h2>\n

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As we have written in past blogs, prior to 2012, the Fed never discussed its policy moves with the markets. The minutes of Fed meetings weren\u2019t published for several years. There was no FOMC statement and no press conference. FOMC members didn\u2019t comment on policy in their speeches.<\/p>\n

Since 2012, with the initial publication of the dots, the FOMC statement, the press conference, and various public speeches by FOMC members, the Fed has had to \u201cmanage\u201d market expectations. Today\u2019s inflation data is clearly moving in the right direction (even acknowledged by Powell), and the Fed is clearly closing in on its inflation goals. But any such enthusiasm could cause markets to pre-empt the Fed and move market rates down before the Fed desires. Thus, the \u201chawkish\u201d pause and the emphasis on \u201chigher for longer.\u201d As a result, in the post-2012 era, besides its monetary policy duties, the Fed has the new task of managing market expectations so that markets don\u2019t pre-empt policy.<\/p>\n

Thus, it is our view that the dot-plot and the higher growth projections were part and parcel of the Fed\u2019s need to manage market expectations. And because of this need to manipulate market sentiment, their forecasting track record has been poor.<\/p>\n

The Money Supply<\/h2>\n

Besides interest rates, the Fed also controls the money supply. At the press conference, Powell said (several times) that the Fed would continue to reduce its holdings of U.S. Treasury securities (i.e., continue Quantitative Tightening (QT)).<\/p>\n

The chart shows the year-over-year changes in the money supply, in this case M2. (M2: cash, demand deposits, time deposits, money market funds\u2026) Note that since the 1960s, M2 has touched the 0% growth line only twice, both in the 1990s. But M2 growth has never contracted like it has in 2023. Monetary economists (Milton Friedman school) believe that the money supply is quite influential in economic growth and inflation. If one looks at the right-hand side of the chart, one can see the explosion of M2 during the pandemic. So, if you believe in Friedman\u2019s ideas, it isn\u2019t any wonder that we\u2019ve had inflation. But, now, for the first time, at least since the 1960s, the growth rate in M2 is negative. Again, for monetarists, it isn\u2019t any wonder that inflation is melting. But wait!! The chart also shows that Recessions are usually associated with a reduction in the M2 rate of growth. So, the M2 contraction is telling us something sinister.<\/p>\n

The fall in M2\u2019s growth to negative territory is corroborated by the meltdown of commercial bank deposits. Like M2, in modern history, there was only a brief period in the 1990s where commercial bank deposits contracted. It was brief and mild. Again, like the M2 chart, you can see the impact of the money giveaways during the pandemic (right-hand side). The free money was in the form of checks drawn on the Treasury which the public deposited in their banks.<\/p>\n

Bank deposits are now in a negative growth pattern as the Fed continues to reduce the money supply by $100 billion\/month by selling Treasury securities from their portfolio. (The Fed sells the Treasury Note; the buyer pays for it with a check; the Fed clears the check by reducing that bank\u2019s deposit at the Fed. That money has disappeared!) Note: as deposits contract, the ability of banks to lend diminishes.<\/p>\n

Similar to the money supply, the following chart shows a negative pattern with federal tax receipts. On the right-hand side, note that tax receipts fell during the initial stages of the pandemic. They then rose at a record pace as the economy reopened, but are now falling, much like the pattern you can see during the Dot.Com and Great Recessions.<\/p>\n

Incoming Data and Economic Growth<\/h2>\n

In other economic news:<\/p>\n