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.
How will the U.S. and global economies fare in 2023? In this month’s letter, Bill Longbrake notes that last year’s forecasts weren’t even close to foreseeing how badly economies ended up performing. Will 2023 bring a soft landing or will it be like “Waiting for Godot?” Or is a crash-landing recession in the offing? Bill fears inflation will remain stubbornly high and force the Fed to continue raising interest rates. He wonders whether China’s exit from its Zero-Covid policy will stoke inflationary pressures by the second half of 2023. The coming year, like 2022, will bring surprises, probably negative on balance. The crystal ball is cloudy, indeed.
In this month’s Longbrake Letter, Bill asks: “Will monetary policy drive the U.S. economy into recession?” No one knows the answer for sure – there are many opinions. What can be said with certainty is that the economic outlook is highly uncertain. He advises decision-makers to avoid falling in love with a particular scenario. Better to consider a range of possible scenarios, understand each one’s implications, then develop risk-mitigating strategies for each. Better yet, engage in a systematic process of updating scenarios and challenging assumptions. On a personal note, Bill observes that during his career as a corporate executive he found it useful to focus particularly on very negative potential outcomes. If they didn’t come to pass, that was great. But if they did, he was prepared.
Strategic competition between the U.S. and China is evolving into a new cold war, which will have dramatic consequences for international relations and the world’s economy. Two significant recent developments define this transition. The first occurred on October 13 when the U.S. Department of Commerce published extra-territorial export sanctions, specifically intended to block China’s rise as an international superpower. The sanctions will cripple China’s ability to design, manufacture and utilize state-of-the-art semiconductor chips. The second occurred on October 22 when the 20th Communist Party Congress elected members of the Central Committee, which in turn on October 23 elected members of the Standing Committee and Xi Jinping as paramount leader to an unprecedented third 5-year term. That completed China’s transition to one-man autocratic rule. Expect confrontations to escalate.
September has had a history of being a difficult month for financial markets – the Great Financial Crisis exploded in September 2008. The hallmark of 2022 has been rapid escalation in inflation and a belated crusade by the Fed to prevent inflation from becoming entrenched and then bringing it down by rapidly tightening monetary policy and financial conditions. While the Fed’s inflation fight is necessary, as events unfolded in September it became clear that U.S. monetary policy is creating instability in global financial markets. What also became more clear during September was that bringing down inflation without crushing the economy - the so-called soft landing - is not a likely outcome. The question now shifts to whether the recession of 2023 will be mild, moderate, or severe.
August is a month for vacations and relaxation. Following Fed Chair Powell’s “bullish-dovish” press conference on July 27th, the S&P 500 stock average rallied from down -17.7% to -9.7% on August 16th. The mood shifted from “the glass is half empty” to “half full.” The market brushed off negative Q2 GDP, worse PCE inflation, and super-hot July employment. But when the July CPI report came in slightly lower than expected, the market rallied hard. Truth to told, the fight to bring inflation down has a long way to go. Risks of accidents and bad outcomes along the way remain abundant. But the Fed is making positive headway in resetting household and market psychology – measures of longer-term household and financial market inflation expectations have come down quite a lot. Much remains to be done to tame inflation. The risks of recession remain high.
Most recent data reports indicate the U.S. economy continues to be very strong and the labor market is robust. However, despite the ugly June CPI report evidence is emerging that inflation may be peaking and that employment growth may soon slow, perhaps substantially. Because of the Fed’s rapid and substantial tightening of monetary policy, optimism has turned to pessimism that the economy may soon be in recession. A plethora of other developments are heightening recession risk including China’s weak economic recovery from COVID lockdowns, Europe’s economic vulnerability as Russia reduces and potentially cuts off vital natural gas supplies, an evolving global liquidity crisis and strong U.S. dollar, plunging stock markets, and fading U.S. federal fiscal income support to households and businesses. Hopefully, the coming recession will be mild.
In this month’s Letter, Bill Longbrake explores whether the Fed will be successful in putting the inflation genie back in the bottle. Although most economic data reports indicate the U.S. economy is very strong and the labor market robust, some preliminary evidence is emerging that inflation may be peaking and that employment and wage growth may soon slow. But the mood in financial markets is dark as the bubble in asset values created by the Fed’s quantitative easing and zero interest-rate policies deflates. Cryptocurrencies and high-flying tech companies have been hit especially hard. Will this lead to financial panic and recession? Longbrake explains why he is confident that the inflation genie will be put back in the bottle. However, like many others, he worries whether this will be accomplished without incurring serious damage.
In April U.S. economic data continued to be very strong but worries about inflation, Fed monetary policy tightening, and the possibility of recession weighed heavily on U.S. financial markets – stock prices swooned, interest rates soared, and financial conditions tightened substantially. Political developments in the U.S. are worrisome. An academic author, Barbara Walter, marshals evidence that America’s democracy is decaying and risks of civil war are growing. In this month’s letter, Bill Longbrake discusses U.S. and global economic trends and summarizes Walter’s analysis of how governments and societies in the modern era devolve into civil war.
Will the Fed’s scramble to fight inflation drive the U.S. economy into recession? Not yet, says Bill Longbrake in this month’s Longbrake Letter. But Russia’s invasion of Ukraine has made the fight even more challenging. Uncertainty is extremely high. Vigilance and preparation for potentially bad outcomes are warranted. Longbrake explains why the slope of the yield curve may not be a good indicator of the probability or recession. He also discusses how deglobalization, which was triggered by COVID, will be amplified by current geopolitical developments, and will result over time in slower global growth and higher inflation rates.
The COVID-19 recession was the second-worst one since the Great Depression of the 1930s. Here we are, not quite two years later, with a booming economy and full employment, thanks to timely and substantial fiscal and monetary policy stimulus. But, it’s not a Goldilocks outcome because inflation has exploded. The public mood is souring and markets are on edge. All eyes are on the Federal Reserve – will it get inflation under control without clobbering economic activity or, heaven forbid, precipitating a new recession? Measures of long-term inflation expectations indicate confidence in success – inflation tamed and strong economic growth – but the situation is tenuous.