Soft landing optimism continues in the U.S. as inflation and the labor market cool. However, consumer optimism faded a bit in August on worries about higher gas prices and interest rates. Stock prices also gave up their July gains, so it was not a good month for investors. Financial conditions tightened, credit standards continue to tighten and bank lending is slowing. As the economy slows, Bill Longbrake cautions that a soft landing is not a foregone conclusion. Recession remains a definite possibility.
In this month’s Letter, Longbrake addresses the question: “Is China’s economy imploding?” One might think so based on the plethora of recent negative news stories. While data indicate growth is weakening and the Chinese economy faces several enormous challenges, in his Letter Longbrake explains why a financial meltdown and collapse of the economy is unlikely to happen, provided policymakers act decisively to facilitate a transition to a consumer-based economy.
Following a better-than-expected June Consumer Price Index (CPI) inflation report, stock prices continued to surge in July reinforcing June’s momentum-driven market. That market has been spurred firstly by a building belief that the Fed will engineer a soft landing, and secondly by vibrant enthusiasm that generative artificial intelligence will lift economic growth and corporate profits. Bill Longbrake agrees that AI will be a significant game changer in coming years driven by a massive investment boom that will lift productivity and growth in economic activity. This will evolve over several years. In the meantime, the possibility of a recession in the next few months remains.
Recession is coming. “It’s OK until it’s not,” according to Ed Hyman, Chairman of Evercore ISI. In this month’s letter, Bill Longbrake explains why a moderate to severe recession is more likely than a soft landing or mild recession. But because the economy has considerable momentum it will be many months before recession sets in. In the meantime, the Fed has shrugged off banking stress and promised to tighten monetary policy further as it fights to bring down stubborn inflation.
In this month's letter, Bill Longbrake discusses the rapidly approaching climax of the debt ceiling battle. Republicans want to reduce current spending increases and slow growth in government debt. Democrats are just as passionate about preserving critical social programs. The two sides disagree on just about everything. After months of talking past each other, President Biden and Speaker McCarthy agreed to negotiate the issues directly. But the Treasury's cash is running out and so is time to reach a deal. While default is unthinkable, most analysts believe financial markets will have to riot to force Congress to act. In the meantime, stress in the banking sector caused by flawed monetary policy is evolving and could lead to serious and broad-based consequences in the coming months.
First Republic Bank’s announcement of huge deposit losses and its need to sell assets was a reminder that banking stress will continue as long as the Fed implements its tight monetary policy to bring down inflation. As the Fed staff’s base case forecast of a mild recession indicates, credit conditions are likely to tighten and slow economic activity in the coming months. Unemployment will increase and as it does credit quality will deteriorate. As that occurs, banking stress will broaden gradually to include credit losses. In this month’s letter, Bill Longbrake reviews three scenarios: soft landing – no recession, mild recession, hard landing – and moderate to severe recession. While, as the Fed staff emphasized, the outlook is unusually uncertain, Bill ponders whether the soft-landing scenario might appear to be the outcome this year, only to be followed in 2024 by a hard landing as credit problems crescendo.
In this month’s letter, Bill Longbrake discusses the failure of Silicon Valley Bank and ensuing turmoil in domestic and international financial markets. He ponders whether the Fed’s quantitative easing monetary policy tool in combination with massive fiscal stimulus in response to the COVID pandemic is responsible for the fragility of the financial system. He observes that the Fed is faced with a hard choice of whether to fight inflation by continuing to raise interest rates at the risk of exacerbating distress in financial markets or to pause raising rates at the risk of high inflation metastasizing.
Sixty-five percent of CEOs and economists expect the Fed’s monetary policy will cause a recession – most likely a mild one – sometime later this year. Bill Longbrake is not so sure. In addition to the “mild recession” scenario, two other scenarios might occur – “soft landing – no recession" and “hard landing.” In this month’s letter, Longbrake describes the three scenarios and their potential consequences. Regardless of which of these or another scenario unfolds, he explains that both short-term and long-term inflationary risks have increased, making the Fed’s mandate to maximize employment with stable prices (2% inflation objective) challenging.
Final 2022 Assessment
Alex J. Pollock and Howard B. Adler in their book “Surprised Again!” observe that financial experts don’t see financial crises coming and when a crisis hits, they are surprised. Moreover, they are unprepared to deal with the crisis and panic erupts. Perhaps chastened by being surprised time and again, financial experts currently place a 65% probability that recession will occur in 2023, albeit a mild one that won’t be very consequential. Will we be surprised again? Will there be no recession? Or will recession trigger a financial panic and devolve into a catastrophic event? The only thing we can be certain about is that we will be surprised again. In Bill Longbrake’s final assessment of the 2022 outlook, he discusses unexpected surprises including high and persistent inflation, slower growth, and much higher interest rates.