Curving Toward Stagflation

This Is Not Normal

Recession Probability

Rough Transition

Whither Inflation

Waking to a Nightmare

The Cleveland Clinic and British Columbia

The latest data shows inflation is still with us at an 8.5% annual rate. That means we can expect the Fed to keep tightening, trying to reduce demand and relieve pressure on consumer prices.

At the same time, we’ve seen declining GDP growth the last two quarters. Some people raise measurement issues. Fine. Grant that and you can say we have stagnant GDP growth. These weak numbers certainly don’t suggest an urgent need to “cool” the economy. But that’s what the Fed is doing.

Markets evidently think the Fed will stop hiking sooner rather than later. They are literally not paying attention to what multiple Fed officials are saying in speeches all over the country. Let’s look at what normally uber-dove Neel Kashkari says:

“The idea that we’re going to start cutting rates early next year, when inflation is very likely going to be well in excess of our target, I just think it’s unrealistic,” Minneapolis Fed president Neel Kashkari said.

He further stated that, “I think a much more likely scenario is we will raise rates to some point and then we will sit there until we get convinced that inflation is well on its way back down to 2% before I would think about easing back on interest rates.” He went on to state that the Fed “is far away from declaring victory on inflation, and while this is the first hint that price movements are moving in the right direction, it doesn’t change my path for rates.”

We have a name for concurrent inflation and recession: stagflation. That term arose in the 1970s when they had high unemployment, which (so far) isn’t a problem this time. But it was also a different demographic situation, with Baby Boomers reaching working age and more women able to enter the workforce. Labor supply was outpacing labor demand. Not so now—though this could change somewhat, we aren’t going to see those 1970s demographic circumstances again. This is new territory.

I’ve noted many times how past mistakes leave our economic policymakers with no good choices. The Fed is inducing recession—or at least amplifying it—in order to control inflation. The mechanism by which they are doing this is the yield curve. It is already deeply inverted and set to become more so.

I have written about yield curves extensively in this letter over the last 23 years. Yield curves as inverted as the current one have always predicted a future recession. Always. While stagnant GDP doesn’t feel like a recession to most of us, the inverted yield curve says we are going to get a recession that feels like a recession.

But if inflation also sticks around, the yield curve could look more like a yield whip over the next year or two—snapping loudly as it constantly adjusts to new events and interventions. Today we’ll revisit the yield curve topic as well as inflation and think about how they may behave going forward.