CAMS Weekly View from the Corner – Week ending 11/18/2022
November 21, 2022
Dating back to early spring of this year we began to intermittently insert the economic landing thought which grew in focus as weeks and months unfolded to the point of offering the topic as subject titles. The economic landing topic comes into the fray when the Federal Reserve begins to tighten financial conditions in order to reign in economic activity that may be running too hot while speculation and price inflation are running ahead of themselves. In this cycle we have certainly witnessed the above general description – in particular the latter aspect of speculation and certainly price inflation. For the Fed’s part we are all aware they have been raising interest rates rapidly as well as reducing the size of their balance sheet which also is a tightening approach albeit less recognized by the general populace. The bottom line is the Federal Reserve led by Chairman Powell is in full-tilt tightening mode via their actions as well as, importantly, their language. When it comes to central banking the certainty of their language relative to the task of fighting price inflation is crucial. The written and verbal certainty impacts collective psychology – in particular that of market participants as well as general players within the economic system. Said participants and players are more prone to get the message and act accordingly when the Fed’s actions are backed up by unwavering language. Wait, this sounds backwards – doesn’t the language come first which is then backed up by actions? When it comes to the dance between the Fed and market participants, at certain points in a tightening campaign, the answer is no. Always remember markets are forward looking to the point of being obsessed with the forward view. They are constantly looking at today’s data/events/storylines and then immediately turn to processing that down the timeline. This brings the importance of the Fed’s double barreled approach of actions followed up by language. If, for example, the Fed were to raise interest rates in the now and then simultaneously offer lackadaisical language that would infer they are not particularly serious about their own actions or concerned about price inflation generally market participants would run with the language on a forward view. Liken this to a child whose behavior has been called out by their parents and yet because of tone of language said child infers “Ah they are not serious let the good times roll!” Similar to the hypothetical child collective market participants could easily infer the Fed is not serious and hence will continue to take speculative action that can ultimately feedback loop to more price inflation. Yes, similar to parenting, market participation has you questioning at times, are you a behavior psychologist or a parent/participant. Is The “Child” Misinterpreting the Tone? In recent weeks collective market participants have sent risk assets higher across various inter-market categories. To varying degrees risk assets have caught bids by participants seemingly because of a building belief that our economic scenario is coming in for a landing. What type of landing – hard or soft – is the central question? The soft landing phrase suggests a scenario whereby the Fed is achieving a painless slowdown in economic activity while not causing any notable disruptions in the general employment market. In this soft landing backdrop price inflation glides consistently and yet notably lower to a point where price inflation is once again a non-topic and through it all the economy continues to grow nicely. With this the Fed is done with further tightening of financial conditions and in fact is expected to begin loosening again. In recent weeks this type of landing seems to be building with increasing belief. The hard landing invokes something much worse. Price inflation remains stubbornly high albeit off peak levels while the employment market begins to reflect stress that trends into consistent deterioration as follow-on general economic activity consistently weakens. The Fed is then between a rock and a hard place in the hard landing scenario as they have a weakening economic backdrop on their hands while simultaneously witnessing price inflation that remains well above their long stated (importantly recently emphasized with their language) 2% price inflation target. (Seemingly they are trying to emphasize – we are serious about this ya’ll!) In the hard landing scenario two old school phrases reenter the scene from decades past. Those are stagflation and the Misery Index. Both reflect and depict the hard landing scenario. In this scene risk assets struggle big time! As we stand here current day our approaching landing is convoluted but leans more toward the hard landing side of the ledger than it does the soft landing. We are beginning to see notable layoffs announced from well recognized corporations, evermore financial stress building from within general households while price inflation, albeit off peak levels, remains very high – think multi-decades high. Enter Chairman Powell Earlier this month Chairman Powell held the post Federal Open Market Committee (FOMC) interest rate meeting press conference in which he spoke for the Committee and conveyed a consistent tone relative to their focus on price inflation. This is the 3rd edition in a row we are sharing perspectives conveyed from Chairman Powell during that press conference because it covered a lot of ground and was a very important discussion in our view. Throughout it he didn’t go light on the messaging which essentially came down to – come hell or high water we will fight this price inflation issue. Per the aforementioned collective market participants behavior in recent weeks relative to bidding up risk assets it seems they have not taken him seriously. We will leave you with an excerpt Q&A discussion below and you can process for yourself what tone the Chairman was striking when it came to the type of landing we may be embarking on. Remember, hard landings and risk assets do not get along well.
NANCY MARSHALL-GENZER. Hi Chair Powell, Nancy Marshall-Genzer from Marketplace. I’m wondering, has the window for a soft landing narrowed? Do you still think it’s possible? CHAIR POWELL. Has it narrowed? Yes. Is it still possible? Yes. I think, we’ve always said it was going to be difficult, but I think to the extent rates have to go higher and stay higher for longer becomes harder to see the path, it’s narrowed. I would say the path has narrowed over the course of the last year, really. Hard to say. Hard to say. NANCY MARSHALL-GENZER. Just real quickly; why do you feel like the window has narrowed? CHAIR POWELL. Because we haven’t seen inflation coming down. The implication of inflation not coming down and what we would expect by now to have seen is that as the, really as the supply side problems have resolved themselves, we would have expected goods inflation to come down by now, long since by now. And it really hasn’t although it’s, actually it has come down but it’s, not to the extent that we had hoped. At the same time, now you see services inflation, core services inflation moving up and I just think that the inflation picture has become more and more challenging over the course of this year, without question. That means that we have to have policy be more restrictive and that narrows the path to a soft landing I would say. https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20221102.pdf
I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis
Footnote:
H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.
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