Podcast Summary
Navigating Economic Uncertainty in 2022: Principal Asset Management emphasizes a 360-degree perspective, combining local insights and global expertise to identify opportunities amidst elevated inflation, a slowdown in China, and a complex reaction function from the Fed. Macro thinker John Turek discusses challenges and questions surrounding persistent inflation and inflation volatility in 2022.
The economic landscape of 2022 is filled with uncertainty, as the world navigates through a business cycle unlike any other in recent history. Principal Asset Management, a real estate manager, emphasizes the importance of a 360-degree perspective, combining local insights and global expertise to identify compelling investing opportunities. The economy is experiencing elevated inflation, a slowdown in China, and a complex reaction function from the Fed. With unprecedented conditions, such as rapid employment growth and pandemic responses, there is no clear playbook for how this cycle will unfold. Macro thinker John Turek, author of the Cheap Convexity blog and founder of JST Advisors, joins the conversation to discuss the challenges and questions surrounding the economic outlook for 2022, including the possibility of persistent inflation and inflation volatility. Stay tuned for a thought-provoking discussion on the future of the economy and markets. (224 words)
Inflation's stickiness and broadening out: Despite initial expectations, inflation's persistence and expansion beyond select sectors indicates excess demand and supply fragilities. The economy is undergoing a reset of wages, making a significant decrease in demand unlikely.
The inflation we've experienced this year is showing signs of stickiness and broadening out beyond just sectors like education and healthcare. This is different from what many expected before the year, given supply bottlenecks and base effects from the pandemic. However, it's becoming clearer that excess demand is also a factor, and the Fed's policy response has had to adjust accordingly. Retail sales and strong wage growth suggest that demand is not likely to decelerate significantly, even as inflation peaks and comes down in the next year. Additionally, supply fragilities, especially in Southeast Asia, have exacerbated price pressures. Overall, the economy is facing a reset of wages, and it's challenging to imagine a significant decrease in demand that would help bring inflation back to the 2% target in an environment where wage growth is robust.
Challenges to bringing inflation down to 2%: Despite relief from labor supply and fiscal stimulus, strong demand and potential service sector shifts keep inflation above target, with uncertainty around monthly prints and potential overshoots impacting growth.
The current economic environment presents challenges for bringing inflation down to the Federal Reserve's target of 2%. While there may be some relief as labor supply increases and fiscal stimulus decreases, demand remains strong and goods prices may not return to the deflationary levels seen in the 2010s. Additionally, the shift towards services consumption and potential normalization of supply chain disruptions could contribute to persistent inflation. The question for next year is whether inflation will be below or much above 3%, and a return to monthly prints around 0.2% would put the economy on track to reach an inflation rate around 2.5% by the end of the summer. This number, while still above the target, would give the Fed room to hike interest rates while avoiding an overshoot that could stifle growth. Overall, the ongoing public sector to private sector handoff and skepticism in the market about future growth make this an important economic story to watch.
Market Uncertainty Over Inflation and Fed Response: Market uncertain about inflation trend in Q2 2023 and Fed's response, keeping 10-year yield low despite tapering and inflation concerns, yield's flattening reflects market's assessment of Fed's hike risks and low r-star world, upcoming June FOMC meeting crucial for clarity.
The market is closely watching the inflation trend in Q2 2023 and the Federal Reserve's (Fed) response to it. If inflation comes down but remains above the Fed's tolerance level, there's a risk that the Fed may need to act more aggressively to prevent a deanchoring of inflation expectations. This uncertainty has kept the 10-year yield low despite the Fed's tapering of its balance sheet and concerns about inflation. The yield's flattening reflects the market's assessment of the risks of the Fed overdoing its hikes and the low r-star world we're in. The upcoming June FOMC meeting is crucial as it may provide more clarity on the Fed's stance. As a leading real estate manager, Principal Asset Management provides local insights and global expertise to help clients uncover compelling opportunities in today's market. Investing involves risks, including possible loss of principal. For more information, visit principalam.com. The low 10-year yield is a mystery given the Fed's tapering and inflation concerns. Some attribute it to banks buying more treasuries, while others think investors are hesitant about the public-to-private handoff and fear a policy error from the Fed. The yield's flattening reflects the market's assessment of the risks of the Fed overdoing its hikes and the low r-star world.
Bond market and equity market on different time horizons: The bond market's focus on potential Fed policy and risk of future rate cuts contrasts with equity market's focus on earnings growth. Bond market's concern causes yield curve flattening, which may not impact equity market the same way. Emerging markets may struggle with weakening currencies due to dollar strengthening from Fed hikes.
The bond market and the equity market are currently operating on different time horizons, with the bond market focusing on the potential for aggressive Fed policy and the risk that the Fed may have to cut rates in the future, while the equity market is more focused on the positive earnings growth expected for the next year. The bond market's concern about the Fed's trajectory is causing a flattening of the yield curve, which has historically been a harbinger of recession. However, the equity market may not react in the same way, as the time horizons for each market are different. Additionally, the impact of the Fed's rate hikes on emerging markets is that their currencies may weaken due to the strengthening dollar, making it more difficult for these countries to service their dollar-denominated debt. The Fed's rate hikes next year may not be the issue for emerging markets, but rather the pace and extent of these hikes relative to market prices. The bond market is currently pricing in a more aggressive hiking cycle than the market's expectation, and this asymmetry could be a challenge for emerging markets.
Fed's Interest Rate Hikes and EM Implications: Fed's rate hikes have historically been dollar positive, but a fourth hike could decrease odds of other central banks following suit, potentially leading to a less dollar-positive environment for EM. The Fed's coordinated approach to hiking rates and ending QE could reduce the dollar's dominance in the market.
The Fed's monetary policy decisions and market expectations for interest rate hikes could have significant implications for emerging markets (EM) in the coming year. The speaker notes that the Fed's hikes from 0% to 1%, 1% to 2%, and 2% to 3% have all been dollar positive, leading to a significant dollar rally. However, if the market prices in a fourth hike, the odds of other central banks following suit could decrease, potentially leading to a less dollar-positive environment for EM. Additionally, the Fed's potential decision to hike rates and end quantitative easing (QE) at the same meeting could signal a more coordinated global monetary policy approach, which could reduce the dollar's dominance in the market. The speaker also notes that the setup for EM in the coming year is binary, with potential for strong US demand and favorable terms of trade offsetting inflation concerns and political developments. Overall, the speaker suggests that EM could enter 2023 with some better buffers than expected, but the outcome will depend on the Fed's actions and global economic conditions.
China's economic policy offset domestic deceleration with global import demand: China's economic policy maintained growth amidst credit tightening by importing demand from strong global economies, particularly the US, and helped mitigate inflationary pressures globally with a stronger currency.
China's economic policy this year was focused on reducing domestic demand through credit tightening, but they were able to offset this deceleration by importing demand from strong global economies, particularly the US. This allowed China to maintain growth and not be a significant drag on the global economy, despite having a much weaker credit impulse. Additionally, China aimed to help mitigate inflationary pressures globally by having a stronger currency. This policy stance is reminiscent of the post-financial crisis era when the West went into austerity and China stimulated, with Chinese demand carrying the global economy out of the crisis.
China's Economic Policy Shift: From Aggressive Stimulus to Domestic Demand Boosting: China may prioritize growth stability over aggressive stimulus in 2022, focusing on domestic demand and implementing targeted measures. The US Fed's new inflation targeting framework and Chair Powell's emphasis on inclusive growth could lead to more accommodative monetary policy.
China's policy response to economic challenges in 2022 may not be as aggressive as in the past, with the government putting a floor on growth rather than implementing massive fiscal or monetary stimulus. This shift became evident with recent macroeconomic stabilizer events, including a hike in the forex reserve ratio, a fiscal backstop, and monetary easing. China's focus on increasing domestic demand and narrowing the confidence interval for growth suggests a more measured approach to economic management, with potential implications for global growth. Meanwhile, in the United States, the Federal Reserve's new flexible average inflation targeting framework and Chair Powell's emphasis on inclusive growth and maximum employment indicate a potential shift towards more accommodative monetary policy, although the extent of future interest rate hikes remains uncertain.
A more proactive approach to addressing inflation: The Fed's unexpected shift towards raising interest rates earlier than anticipated reflects changing economic conditions and a commitment to addressing inflation within its new framework, potentially leading to a faster pace of rate hikes and an end to quantitative easing by June 2023.
While some may view the Federal Reserve's actions as a return to the "same old Fed," the current economic climate and the Fed's updated framework warrant a more nuanced perspective. The Fed's unexpected shift towards raising interest rates earlier than anticipated reflects a reaction to changing economic conditions, particularly high inflation expectations. The Fed's commitment to addressing inflation, even within the context of its new framework, could result in a faster pace of rate hikes than some anticipate. Additionally, the labor market's progress and continued price pressure suggest that the Fed's FATE (Flexible Average Inflation Targeting) checklist could be met as early as June 2023, indicating a potential end to quantitative easing and a more hawkish stance on monetary policy. Overall, while the Fed's actions may resemble past behavior, the economic context and updated framework necessitate a more proactive approach to addressing inflation.
Monetary policy shift driven by inflation and labor market healing: The Fed is expected to raise interest rates more aggressively than anticipated due to inflation and a healing labor market, but the market and economy can handle higher rates as long as the Fed doesn't hit the brakes on the cycle.
Inflation is the primary driver of the current shift in monetary policy, but it's happening in the context of a rapidly healing labor market. This context is influencing the stock market, which has seen incredible gains in 2021 but also intense sell-offs in certain sectors. The market is readjusting to the possibility of more aggressive Fed actions next year than originally anticipated. The odds are close between a few more hikes and fewer hikes, but given base effects starting in Q2 of next year, a 2.5% inflation rate is more likely. This doesn't mean the Fed will hit the brakes on the cycle, and as long as that's the case, the market and economy can handle higher interest rates. However, the long-term impact on stocks when the Fed reaches neutral remains to be seen. Overall, the unemployment rate at 3.5%, inflation at 2.5%, and the Fed at 0.875% on the Fed funds rate could result in decent stock market performance.
John Mueller's Probabilistic Approach to Economic Analysis: Mueller emphasizes that inflation outlook involves not just price increases but also volatility and uncertainty. Fed rate hikes may be fewer than expected due to shifting market expectations. Consumer demand remains strong despite inflation anxiety. Labor and service market tightness illustrated by personal experience.
John Mueller offers a unique perspective on economic trends, particularly regarding inflation, by considering the probability distribution of various outcomes. According to Mueller, the inflation outlook is not just about relentless price increases but also about volatility and uncertainty. He explained that as the Federal Reserve considers raising interest rates, the market's expectations shift, making it more likely that the number of rate hikes will be closer to the lower end of the range. Furthermore, Mueller pointed out that despite anxiety about inflation, consumer demand has remained strong, suggesting that people expect prices to come down. Another interesting point Mueller made was sharing his personal experience with a software glitch in his smart washing machine and the difficulty of getting it repaired, illustrating the labor market tightness and service market tightness that characterize the current economic landscape. Overall, Mueller's clear and probabilistic approach to economic analysis provides valuable insights into the complex and evolving economic landscape.
Bloomberg Launches New Podcast 'Money Stuff': Bloomberg introduces a new weekly podcast, 'Money Stuff', hosted by Matt Levine and Katie Greifelt, bringing their insightful finance discussions to a podcast format. Listen every Friday on major platforms.
Bloomberg is expanding its podcast lineup with the launch of a new show called "Money Stuff," hosted by Matt Levine and Katie Greifelt. This duo previously collaborated on a popular finance newsletter, and now they will bring their insightful discussions to a weekly podcast format. Listeners can tune in every Friday on Apple Podcasts, Spotify, or other podcast platforms. The Odd Lots podcast team, Tracy Alloway and Joe Weisenthal, expressed their excitement about this new addition to the Bloomberg podcast lineup. Don't forget to follow the hosts and producers on Twitter for more updates, and check out the American Express Business Gold Card for reward points on eligible business expenses.
