[Trade For Profit] A little over six months ago, when stocks were still trading near all time highs, former NY Fed repo guru and current Credit Suisse strategist Zoltan Pozsar made an immodest proposal to the Fed: crash stocks to contain inflation, to wit:The FOMC has one big problem: inflation. There are two ways to slow inflation: by hiking short-term interest rates or by forcing long-term interest rates higher. Historically, the Fed used rate hikes to engineer recessions that generated the slack needed to keep inflation in check ("opportunistic disinflation"). With the Fed’s "updated dual mandate" of inclusive low unemployment and the political imperative of redistribution through firmer wage growth at the bottom of the income distribution, the Fed aiming to slow inflation via a recession is unimaginable. Hikes today then are meant to slow inflation without a recession... which is not something that the Fed has ever managed to achieve before.
Zoltan was also confident that "lower risk assets won’t kill growth" and his solution to contain inflation and "to improve labor supply, the Fed might try to put volatility in its service to engineer a correction in house prices and risk assets — equities, credit, and Bitcoin too..." In short: crash everything.
Fast forward to today when once again the Fed has followed Zoltan’s advice to a tee with stocks in a deep bear market, bitcoin in another crypto winter, commodities soared then plunged (with the exception of nat gas and oil), the economy in a technical recession... and yet inflation remains sticky to the upside.
Of course, with oil and gasoline sliding in anticipation of Biden’s recession, and most other commodities at or below Ukraine war levels, it’s unlikely that inflation will remain quite so sticky, especially when considering that yesterday, we saw the ISM-Prices Paid sub-index print 60.0, down from 78.5 prior. This, JPMorgan writes, "...feeds into our house view from Mike Feroli that between now and the September FOMC we should continue to see CPI levels cool due to energy prices/base effects and along with likely softening in jobs data, indicative from higher initial claims recently, leaves us expecting a 50bp hike in September and a more dovish stance for the rest of the year. Jackson Hole at the end of August could deliver more support for the dovish pivot."
Here we completely agree with JPM for once, as it has been our base case for a long time that the Fed will use this month’s Jackson Hole to hint at the coming dovish reversal.
But let’s assume that’s not the case and inflation remains deeply entrenched, Friday’s jobs come in hot, wage growth continues to beat expectations as the wage-price spiral proves unbreakable, and next week’s CPI print comes in far hotter than expected. Well, that in a nutshell is what Zoltan Pozsar’s latest note is all about.
According to the repo guru, inflation is now so embedded, that the US economy may need to undergo a deeper and longer recession than investors (and he himself) anticipate before sharply higher prices can be brought under control.
