INFLATION CONFUSION PLUS RECESSION CONFUSION EQUALS STOCK MARKET CONFUSION

In the last paper I posted in georgeeconomics.com, “Stubborn Inflation – Why…”, I discussed the reality of inflation and some of the major factors that render the Federal Reserve’s efforts of bringing the current untenably high level of inflation back to their 2.0% target a ‘long shot’ in a short period of time.  The question that the economic gurus have been pondering is whether or not the Federal Reserve’s aggressive interest rate policy will result in a deep recession or a shallow (or even no) recession. In effect, these pundits have been prognosticating about the prospects of a hard landing for the economy verses a soft landing as the Federal Reserve continues its tightening efforts in the face of stubborn inflation. What is just now being considered is the increased likelihood of a slow or no landing with stubborn inflation driving the economy into a catatonic state, where the Federal Reserve has to maintain a restrictive tightening posture well into 2024.   

To the public at large, what they are observing, while they suffer under the ponderous weight of federal fiscal irresponsibility in addition to a myopic agenda driven war on fossil fuel, is inflation and recession confusion.  The middle- and lower-income wage earners know the that they are in a recession regardless of how the political elite define and redefine recession. It should be noted, however, the general public is not alone in that confusion.  The ‘talking heads’ that discuss the stock market aberrations and gyrations in esoteric financial terminology on the various media formats are themselves plenty confused.  As a herd, they lock onto the most recent economic data and try to find comparable historical trends to base their market breakdowns and prognostications.  Recently they have bounced back and forth between opining a hard landing versus a soft landing for the economy, as recent month to month data has failed to establish a clearly favorable path for disinflation. This lack of clarity is the impetus for the title of this paper – Inflation Confusion Plus Recession Confusion Equals Stack Market Confusion. 

As discussed in the above referenced paper, the likelihood of a slow landing is becoming increasingly greater as the economy, with all of the tailwinds as discussed in that paper, is bucking the efforts of the Federal Reserve to slow down the overheated economy.  The possibility that the lagged effect of the Fed’s ongoing tightening policy may rear up and create a recession in the near term is still real, but not as likely as a slow landing where the Federal Reserve is forced to drag out its efforts which, at some point, will have the desired effect of dampening demand and, therefore, the economy.  Also as discussed, given that the Federal Open Market Committee has been aggressively increasing the Federal funds rate for approximately a year many Keynesians believe that the lagged effect of their efforts should already be more observable than they are.   It is apparent that misguided agenda driven tailwinds have generated a massively inflationary environment, which in turn, has overheated an already strong economy. This has complicated the efforts of the Federal Reserve, which is stuck with only Keynesian tools that are restricted to demand side actions.  They are limited by having to smother a strong economy to rebalance supply and demand, without the help of supply side fiscal and rational federal spending policies that could do much of the rebalancing work for them.  

Until the economy is sufficiently slowed down such that the Fed’s 2.0% inflation rate target is expected to be achieved in a timely manner, inflation, recession and stock market confusion will continue to be significant issues.  From my viewpoint unless that clarity is reached by the end of Q2 (2023) the Federal Reserve’s tightening stance will remain in place well into 2024.  The Stock Market will have a very bumpy ride until the Federal Reserve reverses its stance (i.e., starts to reduce the target interest rate).  The pundits will continue to prognosticate, and the market will gyrate with volatility, meandering back and forth as preliminary data excites and/or spooks investors and offers the pundits talking points. Select bonds (short and medium term), stable high dividend stocks and radically undervalued companies with strong balance sheets will always be relatively safe bets.  

Always keep in mind that inflation, especially one of extreme dimensions such as the present one following a period of extremely low interest rates and inflation, is extremely sticky and can drag out for an extended period of time. As the unintended consequences of severe inflation and rising interest rates accumulates, such as the failure of poorly run banks (whose security losses due to the inverse relationship between rising interest rates and bond prices made them functionally unable to cover withdrawals*), the likelihood of a bumpy or hard landing and slow economic recovery has increased along with the consequential stock market confusion discussed above. The Federal Reserve is in a very difficult position where they may stop raising interest rates to prop up less secure banks which, in turn, can be expected to extend their fight to tame inflation. Note that the concept of a slow landing does include the possibility of a significant recessionary period and a slow economic recovery.  If there is a bumpy or hard (slow, drawn out) landing, unless the consequential economic damage totally reigns in inflation, even though there remains some excess money yet to completely work through the economy, STAFLATION will remain a possible, highly undesirable, outcome.  As discussed above, the stock market will also experience a bumpy volatile ride well into 2024.  

Note * Regardless of any bank’s loan exposure (which tends to be relatively illiquid), they hold relatively liquid instruments, primarily government bonds, to secure periods of high account withdrawals.  Many of the bonds were purchased during the period of extremely low interest rates which steeply dropped in value as the Federal Reserve increased the target interest rate to combat inflation. As a consequence, in some cases of poorly run and supervised banks, their bond holdings no longer cover a high volume of withdrawals in a short period of time.