Introducing

Joseph G. Carson

Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein.   Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees.   He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.

Publications by Joseph G. Carson

• USA| Jun 28 2022

  The "Income" Consequences of the Fed's Inflation Fight: The Main Reason Recession Risks Is High

  Recession risks are high, in my view, because of the "income" consequences of the Fed's inflation fight. The math is very straightforward: A significant reduction in price inflation means less nominal revenue or sales, weak or negative operating profits, and less labor income. Consequently, the subsequent drop in national income growth would be sharp, rivaling some of the most significant declines on record.

  The Fed aims to bring consumer price inflation back to 2%, down from the current rate of over 8%, a drop of 600 basis points. Slicing 600 basis points off the headline and roughly 400 basis points from the current reading of the core index would cause an uneven distribution of price changes, with prices for many consumer goods posting significant declines.

  Commodities or consumer goods prices rose 10% in 2021. Given the stickiness in service sector prices, inflation for consumer goods would have to show no change or decline a few hundred basis points if the Fed successfully gets overall core prices back to a 2% rate. That would result in a sharp fall in revenue growth for a vast part of the retail sector.

  Yet, the consumer price inflation fall would extend much further. Producer prices for finished goods and intermediate materials are cyclically aligned with consumer prices but are much more volatile. In 2021, producer prices for core materials and supplies rose 23%, 4x the core consumer price index and the most significant increase since the mid-1970s. If the Fed kills consumer price inflation, a record deceleration in prices for materials and supplies is in store.

  The most significant reversal in materials prices occurred during the Great Financial Recession. In mid-2008, these prices were up 12% and one year later off 8%. If material price inflation drops to zero by early next year, it will exceed the price deceleration of 2008-09. As a result, the revenue drop for the materials producers would be substantial, crushing profits.

  In 2021, with significant and broad consumer and producer inflation along with large wage gains, national income, 80% of which is accounted for by operating profits and employee compensation, rose 12%, 200 basis points faster than GDP.

  If the Fed takes three-fourths of consumer price inflation out of the economy and all of the producer price inflation, the drop in nominal income would be sharp, especially when the hit to labor occurs.

  Aggregate income would rise marginally, no more than 4%, and down from the current rate of 11%. That 700 basis points deceleration of nominal income growth would match the drop during the Great Financial Recession. Yet, in this case, it would still be marginally positive. Depending on how quickly firms cut back on labor and other costs, the fall in operating profits would be sharp, off at least 20%.

  The Fed's inflation fight is in its early innings, and the biggest hit to company revenues, profits, and margins is months or even quarters away. Still, the process has started with reports of cuts in advertising and hiring freezes.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Jun 07 2022

  Peak Inflation Is Hollow: It Provides No Context to Reduction in Speed or Duration of Cycle

  Peak inflation is not a meaningful statistic. In some ways, it is similar to peak growth or peak earnings. Indeed, it provides no context to the reduction in speed or the duration of the cycle. It is hollow. The Fed made a mistake in thinking that the spike in inflation was supply-side driven and, therefore, temporary. It would be equally wrong to conclude that peak inflation signals a quick end to the inflation cycle.

  There is a lot of talk of peak inflation as it somehow creates the impression that with inflation coming off its highs, the Federal Reserve has less need to tighten. Yet, peak inflation implies inherent linearity to inflation, which is not the case. Inflation cycles are non-linear. To be sure, inflation cycles rotate, move up and down, and broaden over time.

  The thinking behind peak inflation is similar to the supply-side driven view of the current inflation cycle. Supply-driven inflation, according to some, is temporary as it will fall on its own accord once the unique factors disappear or dissipate in intensity. Yet, the error in that analysis is that it overlooks or ignores the spreading effect of inflation. In other words, as certain costs rise, it forces different prices up over time.

  For example, in the 1970s, supply shocks (food and energy) played a massive role in starting the inflation cycle. After that, however, the inflation process spread, and for more than a year, inflation measures without food and energy costs were rising faster than those that included them.

  A similar script is starting to play out today. For example, consumer price inflation has accelerated by 400 basis points in the past twelve months. Unique factors, such as energy +30%, used cars +23%, and food +9%, accounted for a lot of the spike. Yet, prices other than food, energy, shelter, and used cars accelerated by 330 basis points, rising 5.8%, the most significant acceleration and fastest increase in this broad price index in over 40 years.

  Prices paid indexes are relatively high (low to mid 80%) for manufacturers and non-manufacturers in the May survey from the Institute of Supply Management, and wage costs for the rank and file posted their most significant monthly increase (0.6%) of 2022 in May. So as long as companies are saying costs for materials are increasing and workers' pay is as well, the Fed must conclude the inflation cycle lives on and ignore talk of peak inflation.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| May 16 2022

  The Many Links of Inflation Cycle: Hard Landing Is Needed to Crack Them

  Inflation cycles are complex, with many interconnected parts. Price changes flow unevenly through the distribution and production channels, lifting final product prices. For example, consumer price inflation doubled from 4.2% to 8.3% in the past year. Yet, that surge is directly linked to even more significant price increases for thousands of items in various processing stages. Indeed, producer prices for crude goods rose 48% over the same period, intermediate materials by 22%, and finished producer products by 16%.

  Consequently, taming or reversing the inflation cycle is not as simply slowing or ending the price increases for consumer goods and services. Instead, it requires a broad price reversal across various products and services, impacting production, distribution, and retailing businesses. And that "unwind" process is destabilizing and uneven, resulting in liquidity and cash flow squeezes and profit and income declines.

  The Fed's immediate goal is to bring consumer price inflation back to a 2% rate. Although there are many paths to a 2% inflation rate, the most common, based on recent experience, is a sharp slowing in consumer commodities (goods) prices, which accounts for 40% of the overall CPI.

  CPI commodities (goods) prices have increased by 13% in the past year. Not surprising, these retail prices are nearly perfectly correlated (86%) with producer prices for intermediate materials, which have increased by 22% over the same period. Moreover, the correlation is robust, even removing the volatility from food and energy, with core consumer commodities rising 9.7% in the past year compared to a near 17% increase in core intermediate prices.

  A few episodes have occurred, none recently, in which intermediate materials and consumer commodities prices dropped from double-digit increases to near zero. Fueled by restrictive monetary, prices of producer materials and consumer goods fell hard and fast in the mid-70s and early 80s. Both periods, heavily influenced by supply-side shocks, resulted in economic downturns that ran for sixteen months, nearly a half year longer than the average recession of the post-war period.

  So it is not surprising to hear Fed policymakers say, "it will be challenging, not easy," to bring inflation back to 2% from 8% without triggering a recession. That's because it's never been done. And very easy to see why.

  For a broad set of industries and businesses, equaling nearly half of the economy, there would be a "flash" crash in prices. On average, price increases would drop from annual gains of 10% to 20% in a year to zero. Yet, given the unevenness of price cycles, many firms would even experience price declines. Sharp price reversals would trigger an abrupt drop in revenues and profits, forcing cutbacks in output and labor.

  The unwinding of price cycles creates many losers because the Fed is negatively impacting the flow of commerce and finance through its restrictive policy moves. So far, the losers are in finance-- bonds, equities, and crypto, along with increased volatility. However, investors should expect much more since the Fed tightening cycle, which has just begun, needs to crack the many links of the inflation cycle.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| May 04 2022

  Peak Inflation & Fed Policy: A Relationship Which Should Worry The Fed And Scare Investors

  Some have used peak inflation to create the impression that the worse of inflation news is in the rear and that the Fed has less tightening to do than what many expect. Yet, peak inflation says a lot about what the Fed has to do, which should worry the Fed and scare investors.

  In three out of the last four decades, the US experienced a cyclical rise in inflation (4% and above) that compelled policymakers to raise official rates in response. It didn't matter if the inflation cycles were broad (the early and late 1980s) or narrow (oil spike in the mid-2000s). But policymakers had to raise official rates above peak inflation on each occasion to squash the price cycle.

  No one is thinking the unthinkable that the Fed has to raise rates above the 8.5% increase in consumer prices over the past year. Yet, past experiences provide painful lessons on the level of official rates required to reverse inflation cycles.

  Each inflation cycle has common and unique factors. However, many, including Fed officials, have argued that the current inflation cycle has more than a few items lifting prices temporarily. The Bureau of Labor Statistics (BLS) produces a special aggregate series that removes some things people have cited, so it helps remove some of the noise.

  For example, BLS published a series of CPI less food, energy, shelter, and used car and truck prices. This series removes the recent temporary spikes in food and energy prices linked to the Russian invasion of Ukraine. It also removes the massive spike in used vehicle prices associated with supply bottlenecks owing to the pandemic. Yet, this dumbed-down price series still shows a 5.8% in the past year, matching the highest rate recorded in 40 years.

  So even if this is the inflation rate the Fed needs to target to reverse the inflation cycle, it still calls for a fed funds rate of 6% or more than twice the peak rate shown in policymakers' official rate projections made in March.

  Given how tight the labor markets are nowadays and everything else being equal, it would probably take a 6% fed funds rate to impact consumer demand and dampen inflation by creating more unemployment. At the end of March, there were a record 11.5 million job openings against a backdrop of 6 million unemployed. Never before has the Fed faced a significant inflation cycle with labor markets this tight.

  Yet, I would bet that long before the fed funds rate gets close to 6%, something else would break to stop the Fed. Things that stopped the Fed in the past were an abrupt and sharp drop in the financial markets or a cessation in the flow of credit that could lead to economic and financial instability.

  Given the current market environment, none of those conditions are present, so the risk, for now, is that Fed tightening course could look a lot like those of the past until something else breaks. Investors forewarned.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Apr 14 2022

  The Truth About The Current Inflation Cycle

  Although a few presumably temporary factors have lifted reported inflation well above expectations, it is also true that some elements made it look less troublesome. So what is the truth about the current inflation cycle?

  The Bureau of Labor Statistics (BLS) provides special aggregate price series that remove the noise, or an underestimate from these factors. For example, BLS published a series of CPI less food, energy, shelter, and used car and truck prices. This series removes the recent temporary spikes in food and energy prices linked to the Russian invasion of Ukraine. It also removes the massive spike in used vehicle prices associated with supply bottlenecks owing to the pandemic. On the flip side, it removes the controversial shelter component that no longer captures house price inflation.

  In April, BLS reported this price series increased by 0.6% month-on-month, matching the gain in March and twice that of the 0.3% gain in the so-called core inflation series. This price series has increased by 5.8% in the past year, matching the highest rate recorded in the prior 40 years.

  The surge in this price series also represents a significant milestone. It breaks four decades of lower peak-to-peak consumer inflation rates in the business cycle. Business cycles have shown that there is a cycle in prices. Yet, up until the Volcker era, the peak-to-peak was progressively higher. And after the Volcker era, the peak-to-peak inflation rate has been progressively lower or stable.

  Also, the surge in this price series shows that the current inflation cycle is not a "blip." On the contrary, it is widespread and more embedded in the decisions and expectations of consumers and businesses.

  It is unclear if the current generation of policymakers is aware of the price cycles in the business cycle or how pipeline pressures feed into product prices. For example, the producer price report showed significant increases at all three processing stages in April. It's unlikely that monetary policy can break these price increases with modest increases in policy rates.

  Companies need materials and supplies to protect production schedules. Notably, the April survey of manufacturers from the Institute for Supply Management showed that customer inventories are near record lows. As a result, it would take exceptionally high-interest rates to force companies to pull back on the inventory investment needed to sustain production.

  Although policymakers have yet to list easy money as one of the causes of the current inflation cycle, it plans to make money much more costly to break the cycle. Yet, how far are policymakers willing to take official rates to reverse the price cycle?

  The current official rate projections of policymakers show a peak fed funds rate of 2.8% in 2023, less than half the inflation rate, excluding the unique factors. Never has an inflation cycle been reversed or broken without policy rates moving above the reported inflation rate.

  Investors will soon need to confront whether the higher cyclical peak inflation rate is a one-time occurrence or a sustained shift to higher rates? I bet its the latter because the current generation of policymakers is unaware of how price cycles start and end.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Apr 11 2022

  Investors Beware: Decades-High Profit Margins Will Fall Hard As Inflation Cycle Ends

  Investors should brace for a sharp drop in nonfinancial companies' profit margins as the Federal Reserve raises official rates and shrinks its balance sheet significantly to reduce inflation. History shows that the unwind of inflation cycles tends to trigger an abrupt and sharp adjustment in margins as prices fail to cover overall costs.

  According to the GDP data, real profits margins of 15.3% in 2021 for nonfinancial companies were the highest since the mid-1960s. The significant increase in profits margins, up 2.3 percentage points over the prior year, shows that firms passed their higher costs for materials, supplies, and labor to the end customer. Yet, the inflation cycle's flip side shows that margins get squeezed.

  The last time the Fed faced an inflation cycle as large as the current one and expressed an explicit commitment to reduce it and achieve price stability was in the early 1980s (the Volcker war on inflation era).

  On the surface, today's inflation rate looks less threatening than that of the early 1980s. The current one is more than a year old, while that of the early 1980s was a spillover from the high inflation rates of the late 1970s. Yet, if measured using the same methodology of the early 1980s, today's consumer price inflation rate is as high. Meanwhile, the producer prices for all three processing stages, finished, intermediate, and crude, are significantly higher.

  So what matters more for reversing an inflation cycle; the length of the price cycle or the scale and breadth? Policymakers should presume all three matter, and it will take a significant increase in policy rates and luck to break the current cycle.

  Price cycles are uneven on the way up and equally, if not more so when the process reverses. Policymakers' projection of a miraculous slowing in inflation to its 2% price target (i.e., roughly a 600 basis drop in the reported consumer price inflation rate) and not triggering destabilizing effects in the economy and labor markets is not credible.

  Significant and sharp drops in inflation rates trigger sharp declines in operating profit margins as firms' consolidated costs do not fall as quickly. For example, in the early 1980s, operating profits margins contracted by 400 basis points, and other periods showed even more significant margins decline.

  The reversal in the current inflation cycle will not require as big of a policy adjustment as in the early 1980s. Still, the counter to that is that the labor markets are much tighter, limiting how quickly the firms can control their overall consolidated cost structure. As a result, it would not be a surprise that at the end of this process, firms operating profits experienced a decline equal to that of the early 1980s.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Mar 24 2022

  SNL Fireside Chat With Paul Volcker and Jerome Powell

  Saturday Night Live (SNL) held a fireside chat with Former Fed Chairman Paul Volcker and current Fed Chair Jerome Powell. Here's a replay of their conversation.

  Fed Powell. It is an honor to be on the same stage with you. I think of you as one of the greatest public servants in the history of the Federal Reserve.

  Paul Volcker. Thank you. Those are very kind words. How goes it at the Fed nowadays.

  Powell. Well, we have a little inflation problem.

  Volcker. How bad is it?

  Powell. Consumer prices (CPI) have risen 7.9% in the past year. But at the Fed, we focus on the personal consumption expenditure (PCE) deflator, which has only increased 6.1%.

  Volcker. Why does the Fed look at the PCE and not the CPI? The CPI is what people pay for things, and the PCE includes a lot of non-market prices.

  Powell. That is true, but increases in the PCE run less than CPI, making it look like inflation is less high and harmful. The Fed is in the game of trying to influence expectations, so we picked the lower number of the two.

  Volcker. Selecting a price measure simply because it produces a lower inflation rate is not sound monetary policy. Good policy decisions flow from unbiased and accurate statistical information.

  Powell. That is fair. But we are in the business of managing people's expectations so picking an index with a lower number helps.

  Volcker. What is this rental equivalence that has replaced house prices in the measures of inflation?

  Powell. It is supposed to measure what people can rent their house for if they decide to rent.

  Volcker. How is that inflation? The definition of inflation is what people pay for things.

  Powell. I know. But rental equivalence makes reported consumer price inflation rise less fast when there is rapid house price inflation, and that makes it appear that the Fed is doing a good job. Remember, it's our job to try to manage people's inflation expectations.

  Volcker. But people know inflation when they see it. Nowadays, people have more sources of house prices than they did in the 1970s, so actual inflation or experienced inflation must be much higher. So how much higher would reported inflation be if the CPI were measured similarly to the 1970s?

  Powell. Based on press reports, it would be double-digit inflation, equal to the highs of the 1970s.

  Volcker. Based on press reports? Doesn't the Fed staff know?

  Powell. No. If we don't calculate it, we can overlook it and make it appear that things are always better than they are. Remember, it is our job to try to manage people's inflation expectations.

  Volcker. That's a section of monetary policy I never read or learned. So what are the critical drivers or sources of this inflation nowadays?

  Powell. Most of the increase in inflation is due to supply shortages and bottlenecks emanating from the pandemic. But in recent months, inflation has broadened.

  Volcker. I thought the Fed has consistently argued that inflation is always and everywhere a monetary phenomenon. How fast have monetary aggregates been expanding.?

  Powell. We don't look at money nowadays.

  Volcker. The Fed is in the business of making money.

  Powell. That is true.

  Volcker. So how fast?

  Powell. Broad money has increased by over 40% in the past two years.

  Volcker. How much?

  Powell. 40%.

  Volcker. Uh-oh! And the Fed is surprised by the surge in inflation?

  Powell. We are committed to fighting inflation and plan to front-load official rate increases.

  Volcker. Front-load? What do you mean by front-loading?

  Powell. Policymakers see the Fed funds rate at 1.9% at the end of 2022 and 2.8% at 2023. So we plan to hit those targets earlier.

  Volcker. When I was Fed Chair, front-loading involved lifting official rates before consumer prices surged. It seems to me the Fed is back-loading rate increases, trying to catch up to inflation.

  Powell. Remember, it is our job to try to manage people's inflation expectations. So far, people and investors still think we are doing a good job.

  Volcker. The pendulum of central banking has fundamentally changed, moving away from things it can control and basing policy success on influencing people's expectations. How did the Fed fall into the trap of assigning so much weight to people's expectations and not actual statistics?

  Powell. I hope history will show that we are committed to price stability as much as you were. But, remember, we are judged by a different standard---people's expectations (although no one knows how to measure them)--and not actual inflation.

  Volcker. I wish someone could give me one shred of neutral evidence that inflation expectations lead to actual inflation and not that persistent inflation leads to higher expectations.

  Powell. When facts change, I will retire my views. Thank you.

  Note. Paul Volcker passed away on December 8, 2019. So his responses are my words of what I think he would say today.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Mar 21 2022

  The Fed's Biggest Inflation Problem: Record Surge in Equity Asset Prices

  The Fed finally admits it has an inflation problem. Yet, what is the bigger inflation problem and potentially more destabilizing to the economy as it unwinds? Is it the 40-year high in consumer price inflation, or is it the surge and record valuations of asset prices? Of course, policymakers would say it's consumer price inflation. However, I would argue its asset prices since easy money has fueled a record surge in equity prices, lifting macro valuations far above the dot.com bubble.

  Asset inflation has been a dominant feature of business cycles for the past two decades or more. And, over the past two years, helped by an avalanche of liquidity as the Fed doubled its asset balance sheet to $8.5 trillion, the market valuation of domestic equities to nominal GDP (i.e., the Buffett Indicator) has jumped to levels never thought possible. At the end of 2021, the market value of domestic equities to nominal GDP stood at 2.55.

  It is worth noting that before the pandemic, the Buffett Indicator hit a record high at the end of 2019, surpassing the peak level of the dot.com bubble. In other words, the Fed's easy money policies that resulted in an over-valuation of equities at the end of 2019 created a mind-boggling extreme over-valuation at the end of 2021.

  To put the equity market's valuation in perspective, if equity prices dropped 25% in 2022, or a decline four times bigger than the decline in the S&P 500 to date, that would only bring the Buffet Indicator back to the peak of the dot.com bubble. And a drop of nearly double that scale to bring it to the average of the past two decades.

  Before the last two years, history shows several years of negative returns following periods of extreme overvaluation. Yet, the S&P equity index has jumped nearly 50% over the past two years, while the Nasdaq is up over 80%. So instead of correcting in value, the equity market moved into a new orbit of over-valuation.

  If there are laws of gravity in finance, the equity market is in for a big hurt. That's because monetary policy is a blunt instrument. As policymakers use traditional and non-traditional monetary policy tools to kill the consumer price inflation cycle, it will hit asset prices hard. Moreover, given the scale of over-valuation, the potential decline in equity prices could rival the "big" ones of years past. So investors should take note: history sometimes repeats itself in the world of finance.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Mar 10 2022

  Fed's Decision: "Go Slow" or "Go Bold"?

  In the movie "Draft Day," Kevin Costner, the GM of the Cleveland Browns, tells a stunned GM of the Seattle Seahawks of a last-minute trade involving current and prospective draft picks that Seattle got from Cleveland only a few days ago "We live in a different world than we did just 30 seconds ago." The Fed also lives in a different world than just 30 or 60 days ago, meaning what many Fed officials thought would be the appropriate policy stance when they exited the January 25-26 FOMC meeting is no longer adequate or sufficient at the March 15-16 meeting.

  At the press conference following the January FOMC meeting, Federal Reserve Chair Jerome Powell stated, "it will soon be appropriate to raise the target for the federal funds rate." Since that meeting, most policymakers have hinted that they would support a 25 basis points hike in the federal funds rate at the March meeting.

  Yet, a 25 basis points hike in the federal funds rate would result in the real federal funds rate being lower in March than it was estimated to be in January. The reason is that reported consumer price inflation is markedly higher. To be sure, the reported twelve-month change in the consumer price index at the January meeting was 7%, and now through February 2022, it's almost 100 basis points higher at 7.9%.

  At next week's FOMC meeting, will policymakers adopt a "go slow" or a "go bold" strategy? Betting odds indicate a "go slow" approach. Yet, if policymakers want to change the narrative and regain credibility on fighting inflation, "go bold" would be a better decision.

  Ideally, a "go bold" strategy would start with a 50 basis point hike and end the promise that official rate increases would be gradual, modest in scale, and only occur at regularly scheduled meetings. Breaking the inflation cycle and inflation psychology requires bold moves.

  In 1994, former Fed Chair Alan Greenspan stated, "If the Federal Reserve waits until actual inflation worsens, it would have waited too long." Policymakers have waited too long, and it's now incumbent on them to move quickly and limit the downside risks to the economy that have accompanied every inflation cycle of the past 60 years.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Mar 01 2022

  Manufacturer's Buying Policy Signal Firms Are Expecting Persistent Inflation

  In February, the Institute of Supply Management (ISM) reported that the lead time for capital expenditures, production materials, and maintenance and repair supplies hit record levels. Lead times for CAPEX jumped six days to 173 days, materials two days to 97, and maintenance four days to 50.

  Leadtimes are a valuable indicator of current and future demand. When backlogs rise and get stretched out, firms protect their production schedules by building safety stocks and placing long-dated orders for materials and supplies to meet expected future demand.

  The current generation of policymakers probably does not follow lead times, but the old generation did. (Read the 1994 transcripts of the Federal Open Market Committee meetings). Former Federal Reserve Chairman Alan Greenspan religiously tracked lead times, order backlogs, and delayed deliveries (i.e., vendor performance or supplier delivery index) as signs of future inflation and inventory building. The latter is an essential part of demand-driven fast growth and inflation cycles since it adds a layer of demand, putting more pressure on prices.

  In February, the customer inventories index stood at 31%, with 16 industries reporting too low and none reporting too high. The ISM report indicated that February marked the 19th consecutive month customer inventories were at historically low levels. The prices paid index of 75.6% remains relatively high, and 17 industries reported paying more for raw materials and none paying less.

  In 1994, with a set of lead time, suppliers index, and price paid data that is not as scary as today, the old generation of policymakers saw the need for substantial monetary restraint to break the inflation cycle and limit the cyclical rise in general inflation. That policy playbook worked as pipeline price pressures never reached the consumer level.

  It's too late for the current generation of policymakers to follow the 1994 playbook as pipeline price pressures are present at the consumer level, with more to come. Yet, policymakers can make things worse by not acting quickly and aggressively. Russia's invasion of Ukraine complicates the timing of monetary policy adjustment, not the scale, as the stance of monetary policy remains far too easy to break the inflation cycle.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Feb 22 2022

  The Fed's Problem: "It's All About The Money"

  The Fed has a problem. It's in the business of creating money, but it formulates monetary policy without regard to money itself. So in times when its policy decisions produced a record surge in broad money, policymakers are not attentive or alerted to the negative (inflation) consequences.

  From February 2020 to the end of 2021, broad money increased by $6.5 trillion or over 40%. That increase over less than two years is roughly equivalent to the rise over the previous ten years. Yet, policymakers who have long argued that "inflation is always and everywhere a monetary phenomenon" called the surge in inflation transitory, owing to supply bottlenecks. Had policymakers still recognized money as a potential source of inflation, it would not be in the pickle that they find themselves today.

  Policymakers now face the unprecedented challenge of dealing with consumer and producer inflation and elevated asset prices ( possibly bubbles.) Policymakers' record on reversing inflation cycles and recognizing asset bubbles is lousy. Policy adjustments have always been late (except for Greenspan's 1994 preemptive strike), resulting in awful economic and financial outcomes, some much worse than others.

  As bad as policy decisions were in the past year, it is reckless that policymakers are still easing policy today. Publically saying the monetary policy is "wrong-footed" but not doing anything until the next policy meeting, a month away, is like saying we want the fire to burn some more before being compelled to distinguish it.

  Before the preemptive strike against emerging inflation pressures in 1994, Fed Chair Alan Greenspan stated in his semi-annual monetary policy testimony, " if the Federal Reserve waits until actual inflation worsens, they would have waited far too long." It's too late to use Mr. Greenspan's playbook, but policymakers still need to act swiftly. Some policymakers have argued that only a modest adjustment in official rates is needed because of well-anchored inflation expectations. That is short-sighted and wrong. Actual or realized inflation leads to changes in inflation expectations, not the other way around. Persistent inflation will increase inflation expectations over time.

  Several decades ago, the Bureau of Economic Analysis (BEA) created the monetary and financial flow index (MFF). It consisted of the growth in broad money (adjusted for inflation), change in business and consumer credit, and liquid assets. BEA stopped publishing this series in the early 1990s, and I recreated the series with assistance from BEA, plus updating the series for new financial instruments, such as new flows into bond and equity funds.

  The MFF index was a helpful gauge to predict the peaks and troughs of economic growth cycles and pinpoint excess liquidity situations. The MFF index signaled excessive liquidity growth ( i.e., well above GDP) before the dot.com and housing bubbles. The primary source was explosive private sector credit growth and robust gains in liquid assets.

  Over the past year, growth in the MMF index has been more than twice that of dot.com and housing bubbles, owing to record growth in broad money and bank credit. Too much liquidity is the fuel for inflation.

  The Fed started this inflation fire by creating too much money. Now, it has to produce less. In January 2022, broad money is up roughly 14% in the past year, down from 25% a year earlier, but still far too fast to kill the inflation dragon. Policymakers have to curtail money growth to a rate well below nominal GDP. That will require a substantial increase in official rates and a sizeable shrinkage in the balance sheet.

  Removal of liquidity will appear in asset prices, financial ones before tangible, long before it shows up in conventional measures of inflation. Mr. Market, the biggest beneficiary of Powell and company liquidity bonanza, will soon cry about too little liquidity. Investors forewarned.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• Global| Jan 11 2022

  Blunders By Fed Spells Trouble For Risk-Assets

  Try to recall a period when the Fed has misjudged inflation and labor market dynamics as poorly as they have in the past year. The Fed initially called the inflation jump "transitory," only to back away from that assessment when it continued to move higher and broaden. Consumer price inflation will end the year near 7%, the highest in several decades. At the same time, despite growing evidence of labor shortages, the Fed continued to argue it still did not meet its full employment mandate. If an unemployment rate of 3.9% at year-end, down nearly 300 basis points in a year, and a 5.8% increase in average wages for non-supervisory workers, the highest jump in several decades, is not evidence of an economy well-beyond full employment, then what is it?

  Never before has the Fed continued to ease policy in the face of sharp increases in prices and wages. As flawed as the current monetary policy stance is nowadays, the more significant issue is how policymakers undo the past year's mistakes. Because of adhering to rigid rules of communicating a policy change well before and only at regularly scheduled meetings, policymakers cannot lift official rates for a few more months. Being late on rate adjustments suggests that modest policy steps to contain inflation and emerging imbalances would not be enough. Uncertainty over monetary policy spells trouble for the economy and deepens the downside for risk-assets.

  A few weeks ago, Randall Forsyth, Associate Editor, Up & Down Wall Street columnist at Barron's, interviewed Mr. Felix Zulauf, a longtime member of the Barron's Roundtable. Mr. Zulauf expects a sharp drop in the S&P 500, falling to 3000, as "the markets are about to be slammed by a reversal of the extraordinary fiscal and monetary stimulus applied to fight the pandemic. While policies remain loose, what counts is the change in, rather than the absolute level of, stimulus.

  Mr. Zulauf did not offer a forecast for fed funds, Yet, history shows that it requires a fed funds rate above consumer price inflation to reverse or stop inflation cycles. That does not mean the Fed needs to raise rates equal to peak inflation. Policymakers are more concerned about persistent inflation, running well ahead of its 2% target. Suppose we assume roughly half the rise in consumer price inflation in 2021 is pandemic-driven, probably an overly generous assumption. In that case, that still results in an underlying inflation rate in the 3.5% to 4% range and a policy rate of equal scale. Yet, policy rates might never reach that scale as it would trigger declines in asset prices similar to or greater than Mr. Zulauf's forecasts.

  Mr. Zulauf did not offer any timeline for the sharp drop in equity prices. But he felt the sharp decline would "shake authorities," forcing them to stop and reverse course at some point. An equally bullish view follows Mr. Zulauf's bearish outlook. He believes the Fed will turn on the monetary spigots again, triggering a rally in the S&P 500 to 6000. A u-turn of that magnitude is not a 2022 event.

  In my view, with the market valuation of equities trading 2X times GDP, above the tech-bubble levels, risk assets are most vulnerable to a rapid change in Fed policy. An increase in official rates spells trouble for equities, and a decision to shrink the balance sheet at some point would be doubly bad as the latter would lift long-term rates and reduce the present value of future cash flow. Blunders by the Fed in 2021 come with a cost---higher rates, increased volatility, and sharply lower equity prices in 2022.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints