The US Economy Is (Still) Fine
One of the themes we talk about semi-frequently on these pages is that the mainstream news media is not incentivized to tell you that everything is fine.
To the contrary they are, in many ways, professionals in stoking your worst fears and even occasionally seeding panic. After all, media organizations need to come up with something to get you to stick around and pay attention.
As Justin argued last week, a lot of the internet is just an attention machine and while the need for ad revenue could be evolving, it still drives a lot of behavior, on and off the world wide web.
Therefore, the end result of the output from these attention merchants isn't always great and one of the goals of this newsletter is to try and put some context and perspective around the media's innate negative bias and help you understand what is likely true, what is just fluff and what is perhaps total junk, to put it kindly.
To be fair to the media, they are often doing their level best to distill what the highly paid and credentialed experts are saying. For instance, when the Federal Reserve and much of the economics brain trust - private and public - was telling you that "the current inflation was transitory" it is a bit hard to blame the editorial staff of the New York Times for not disagreeing.
Trust but verify is a neat saying but can only take you so far. Some stuff can't be verified yet.
Therefore, we have long thought there is both some value and some importance in having a space where, when possible, other arguments and possibilities get raised.
That is what we try to do here by asking and trying to answer questions like:
What if the Omicron variant isn't as bad as Delta?
What if inflation isn't transitory?
What if student loan debt forgiveness as it is currently proposed creates more problems than it solves?
What if stable economic growth is the single most important element to enriching the world and solving the climate crisis?
What if deficits do, actually, matter?
Perhaps one of the cleanest examples of our attempt to raise other possibilities has been some of the casual assumptions around what the "obvious" consequences of inflation will be.
The largely uncontested argument was that if:
Inflation is high -> then the central bank will raise interest rates -> this will inherently slow economic growth and finally -> lead to an economic recession in the US.
Now, we worried about this too. We wrote frequently in 2021 while inflation steadily rose that eventually this could lead to a brutal recession as the US central bank tried to hammer the inflation toothpaste back in the tube.
But we also have argued consistently that it was
Critically important to watch the US economy very closely to see if this was actually occurring.
Also, stay alive not just to the possibility that it doesn't but also that, perhaps, the real risk lay in the other direction.
This happens a lot in markets and in life. The big thing that everyone casually worries will happen just never ends up actually happening. Instead, something else occurs that catches everyone wrong footed.
For example, a recent piece of ours in this genre was that everyone of a certain political persuasion was so worried about "Big Tech" monopolies that they didn't even bother to notice that the Google/Facebook duopoly was being rapidly eroded.
The risk might be TikTok, not big Tech.....
To apply this framework to inflation and the contemporary US the important question far too few people asked in the last 6 months of 2021 was:
What if the US economy remains resilient in the face of the fastest rate hike cycle in economic history?
And what if that means that the worry isn't declining growth but rather stubborn inflation?
As someone else said this week, if the biggest story of 2021 was inflation, the biggest story of 2022 was how the US economy withstood the interest rate increases brought about by that inflation.
Well, we had two relevant details around this debate this week:
Both revealed a familiar theme:
The risk for the US economy, the US Federal Reserve and investors in the US and beyond is perhaps not a recession, deep or otherwise. Rather the bigger risk at present is stubborn inflation and all the consequences that go along with that.
This was the week that, for a lot of investors, the other shoe out of the above statement seems to have dropped. Instead of celebrating lower inflation and resilient economic growth, they were confronted with the downsides of those outcomes.
Here is how inflation print looked:
Overall, US CPI moved down to 6.4% in January. the 7th consecutive decline in the year-on-year rate of inflation and the lowest level since October 2021.
But it was also less than the consensus expected and the pace of decline moderated. On a month by month basis, inflation rose by 0.5% in January following a 0.1% increase in December.
This gives strength to the arguments that we have made before about higher inflation being a risk and also that expecting that the war was won and that inflation would decline inexorably to be very unwise.
Or as Chair Jay Powell himself said at an event organized by the Economic Club in Washington, D.C.
This process is likely to take quite a bit of time. It’s not going to be… smooth, it’s probably going to be bumpy.
This week's "sticky" inflation print revealed that bumpiness perfectly.
If US CPI was mixed, US Retail Sales, on the other hand, smashed expectations and proved that the strength of the US economy still lies with its mighty consumer.
The numbers:
Retail sales rose 3% in January, easily topping the 1.9% expected
The numbers are not adjusted for inflation, meaning that consumers the 0.5% inflation rate for the month.
Here is what that looks like:
Put both of these together and it is both evident why markets also had a "bumpy" week and also why it gave investors nearly everywhere.
First, is that resilient economic growth and stronger inflation are two sides of the same coin. You can't have one without the other.
And second, here was the final outcome of all this new information. The expectation of future interest rate increases rose, not just here in the US but around the world:
The US economy is growing more than expected which means -> US inflation is staying higher than expected -> which, in turn, means the cost of capital is going up for all.
Further, if inflation is tough to defeat in the US then it will likely also prove challenging elsewhere as well. If the US economic goose can ignore interest rate increases, then perhaps so can the European (or Japanese or Canadian) gander.
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Have questions? Care to find out more? Feel free to reach out at contact@pebble.finance or join our Slack community to meet more like-minded individuals and see what we are talking about today. All are welcome.
