2023 INFLATION FORECAST

Q: While the Fed Governors are still talking about raising interest and keeping them there for all of 2023, the financial markets are moving interest rates down. They are no longer doing the bidding of the Fed. Can you explain what is going on?

The financial markets now recognize that the Recession has arrived. Given those markets, it’s time for the Fed to stop tightening, if not begin to lower rates. And if the Fed won’t do that, the markets can do it for them. Not that the Fed will like it. The Fed, of course, does care; otherwise, why would they send out FOMC members with hawkish comments?

The chart above shows that the 10-Year Treasury Note peaked at 4.24% on October 24th, then again at 4.21% on November 7th (4.21%), and at a lower level (3.88%) on December 28th. (It is a similar story for the 2-Year Note (4.72% on November 7th, 4.55% on November 21st, and 4.46% on January 5th.) Note the downward trend and the lower peaks. As we write, those yields stand even lower (3.48% for the 10-Year; 4.18% for the 2-Year), well below the recent peaks.

This has occurred despite the Fed’s FOMC members' attempt to jawbone rates higher and in the face of the nearly 100% chance of a 25-basis point rate hike at the February 1st Fed meeting (raising the Fed Funds Rate to the 4.50%-4.75% range and the promise to raise further to the 5% level.

Q: I recall that in a podcast you did several months ago, you postulated that the Fed would have trouble controlling the yield curve when it came time to pause rate hikes. It looks like this is occurring. Would you care to comment further?

?Several months ago, in this podcast series, we did postulate that, in this new era of Fed “transparency,” the financial markets would reinforce the Fed’s tightening moves by rapidly moving market rates to the Fed’s indicated terminal rate (as markets gleaned from the dot-plots). However, we said when it comes time to “pause” (stop hiking) or “pivot” (cut rates), like in the tightening phase, markets would move rates down, but at a much faster pace than the Fed desired. And that’s the case today because the economy is weakening and inflation is melting.

?To combat such market moves, Fed rhetoric has been extremely hawkish. And it worked for a while (the November 7th and December 28th intermediate peaks). But no longer, especially given the meltdown in the inflation data and almost daily new evidence of a faltering economy. It appears that the “bond vigilantes” have re-emerged and have wrested control of much of the yield curve from the Fed.

?Q: You said that the reason the market is moving rates down is that the economy is weakening and inflation is melting. The Fed looks at the labor market and doesn’t see it weakening much. What’s your take?

The evidence that a Recession has begun is evident except in the traditional measures of the labor market like the unemployment rate. We suspect the unemployment rate has been sticky due to labor hoarding after a couple of years of insufficient labor supply. Instead of shedding employees, firms are adjusting to the Recessionary climate by aggressively slashing the workweek and overtime (see charts).

In addition, the headlining Payroll Survey doesn’t distinguish between full- and part-time jobs. That data is found in the Household Survey, and December’s report confirmed a 670K+ move to part-time work.

?An almost daily occurrence of late is a headline about layoffs, especially in the tech world (i.e., America’s growth industry). Some examples:

·?????Amazon: -18,000

·?????Alphabet (Google): -12,000

·?????Meta (Facebook): -11,000

·?????Microsoft: -10,000

·?????Salesforce: -7,000

·?????MMM -2500

The list goes on. It seems like we get a new large announcement almost daily.

In the end, a total and comprehensive view of the labor market leads to a much different conclusion about its strength than one would glean from the traditional unemployment rate alone (clearly, the Fed does not have this view).

?Q: That’s the labor market – any other data regarding the economy’s condition?

·?????The Leading Economic Indicators have fallen for eight months in a row and in nine of the last 10. This has never happened outside of a Recession.

·?????The monetary aggregates say Recession. M1 has turned negative, and M2’s growth is 0%, the lowest growth rate in the history of this series.

·?????The banks that have reported this earnings season have all significantly increased their loan loss reserves, so we know what they expect. We have commented in the past about the rapid runup in credit card balances as consumers attempted to maintain their living standards. Discover, Inc. now expects its charge-off rate to rise to 3.9% in 2023, up from 1.8% last year.

?·?????S&P 500 companies that have already reported earnings for Q4 are showing up at -10.5% on a Y/Y basis.

?·?????Retail Sales, which have been hugging the flatline all year long, turned negative in November (-1.0% M/M) and worse (-1.1% M/M) in December. After adjusting for inflation, Real Retail Sales fell at a -2.5% annual rate in Q3 and Q4.

·?????Industrial Production fell -0.8% in December on top of November’s -0.6% data point. This index has been negative or flat in four of the last five months and six of the last eight. The ISM Manufacturing PMI, which measures expansion (>50) or contraction (<50), fell below 50 in both November and December.

·?????Worse, Manufacturing Production fell -1.3% M/M in December (-1.1% in November), and Capacity Utilization fell to 77.5% (December) (79.5% in October).

Q: You also said that inflation was melting. What evidence do you have of that?

·?????Let’s start with shipping costs. Remember the port back-ups in mid-2021? Remember how the cost of shipping skyrocketed? Not so today. The Baltic Dry Index shows that shipping costs on the high seas have melted, down -76% from the peak, clearly resulting in a fall-off in demand.?

·?????The ISM Survey of Manufacturers shows that supplier delivery delays are below pre-Covid levels, as order backlogs, both indicators of normalization of supply chains and a cooling of inflation.

·?????The Prices Paid Index shows a significant decline in inflationary pressures to the point where the price increases are lower than in pre-Covid 2018 and 2019. In the latest survey, for every manufacturer raising prices, 2.5 were lowering them!

·?????CPI (Consumer Price Index) and PPI (Producer Price Index) are the popular inflation indexes – one would say the “go to” indicators. Inflation in the CPI over the past six months is just +1.9% Annual Rate over that time frame. PPI for December fell -0.5%, the largest fall in that index since the lockdowns (April 2020). The Wall Street consensus estimate was -0.1%, so this was a big surprise. On a Y/Y basis, PPI was +6.2% in December vs. +7.3% in November, and a consensus estimate for December of +6.8%. Core PPI (ex-food and energy), watched closely by the Fed, was +4.6% Y/Y. We expect this to be 2% or lower by mid-year!

·?????Then, these rents have a 30% weight in the CPI. But the BLS’s rent calculation lags reality by 6-9 months, as you can see in this chart shows the BLS’s recent rent calculation versus reality.

·?????The left-hand side of the next chart shows the Zillow Rent Index's rapid fall over the past few months. The right-hand side shows the volume of multi-family units under construction – at a record high rate. This assures us that rents will continue to fall as this inventory enters the market in 2023, another reason why inflation will continue to melt over the foreseeable future.

Q: That certainly is much evidence that inflation is melting. Any final thoughts?

?Incoming economic data says the Recession has started. Incoming price data says inflation is melting. Since each of these alone presages lower interest rates, together, they leave no doubt even despite a reluctant Fed.

?This is a chart of 49 years of the history of both the S&P500 and Historical returns in the Treasury Bond Market. Most of the time, the dot is in the upper right-hand quadrant, as most of the time, both stock and bond yields are positive. Some years bond yields are positive, while stock yields are negative (left-hand quadrant).

There are years when stocks rise and bond returns fall, but not many – that’s the lower right-hand quadrant. Then, there is the lower lefthand quadrant, when both stocks and bonds have negative returns. Note that there is only one dot in the lower left-hand quadrant.?Last year was the only year in modern history where both equity and fixed-income returns were negative.

While this year has just begun, we know that, at year’s end, 2023 will not appear in the lower left-hand quadrant because the fixed-income market will show positive returns. YTD, they already have! And because of the Recession and inflation’s demise, interest rates will almost certainly be lower at year’s end than at its start.

WATCH OUR CORRESPONDING VIDEO HERE .

FOR MORE NEWS, VISIT HIDDENTRUTHS.TODAY