Re: Inflation/USD - The Four Horsemen of US Resilience Will Make the Fed an Uneven "Distributor of Pain."

US Resilience is going to force the Fed to break RoW first, and the Fed will become an Uneven "Distributor of Pain" through the USD Wrecking Ball transmission mechanism.

I recently wrote a piece in which I compared the Fed to Ivan Drago, who famously said “I must break you” to Rocky in Rocky IV. As with most analogies, this one is imperfect, because in my Bizarro version of this tale, the Ivan Drago Fed will be the last man standing in its Inflation Fight.

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I believe there are multiple reasons for why the US Economy is proving more resilient (and by implication why US Core Inflation is proving stickier) than the economies of most other major regional blocs/countries. The US Economy sports various types of “Structural Armor” that make the transmission mechanism of the Fed’s restrictive Monetary Policy less effective domestically and more effective abroad.

In homage to Metallica, whom I recently saw at SoFi for my 17th and 18th shows, I present to you:

The Four Horsemen of US Resilience

1. Demographic Tailwinds

2. The Fiscal Dominatrix

3. Less Floating Rate Dependence

4. Energy “Independence”

As a result of these Four Horsemen of US Resilience, the USD Wrecking Ball as a transmission mechanism of Fed Policy to the Rest of the World (RoW) will be an Uneven "Distributor of Pain."

Horseman 1: Demographic Tailwinds

I’ve covered my theory of why I believe the US is experiencing relative stickiness in both Labor and Shelter Inflation in the Ivan Drago post above, but here is that section:

Europe and the UK share some of these Demographic Tailwinds to Inflation as well, and I believe the root cause of these similar Demographic trends stems all the way back to the Post-WWII Marshall Plan reconstruction efforts that spawned Baby Booms in the US, Europe, and the UK.

Asia experienced the opposite. We all know that a Baby Bust happened in Japan Post-WWII, which has quite clearly forestalled their efforts to revive their economy for decades. As for China during that period, the population had just been ravaged by Japan and its own civil war — with the worst of Mao’s policies yet to come.

Horseman 2: The Fiscal Dominatrix

No, I’m not talking about Fiscal Dominance per se, but perhaps what the two have in common is the mixture of Pleasure and Pain.

Not to mix metaphors, but the Fiscal Dominatrix materialized primarily from the conflicting imperatives of politicians looking to shower the electorate with Fiscal Stimulants (during and after COVID) versus the Fed looking to administer Monetary Depressants to combat Inflation.

I call this the “Vodka/Red Bull” Effect:

No other economic bloc or country has pursued this policy mix to this extent. The implication is that Fiscal “Pleasure” now will lead to much more Monetary “Pain” from the standpoint of Higher For Longer (H4L) policy.

The next two charts from Moody’s and Tax Foundation compare the US Fiscal Response during and after COVID to Fiscal responses in other countries:

Not only did direct Fiscal Stimulus continue to get applied after a COVID vaccine was found, the lag effects continue to be felt years later.

This chart from Brookings shows the long tail of these policies. Notably, it doesn’t even include the forward-looking impacts of the ~$2T in combined spending from the The Bipartisan Infrastructure Law (BIL), the CHIPS & Science Act, and the Inflation Reduction Act (IRA).

Nor does it include the Fiscal Impact of Re-Shoring in response to deteriorating US/China Relations. In my US/China Event in May of this year, Peter Zeihan talked about how the End of Globalization buttressed by Re-Shoring would lead to Structural Inflation for years to come (I don’t agree with the magnitude he suggests but do agree with the underlying Structural Tendencies):

The synopsis of that entire event can be found here:

In contrast to these US Fiscal Tailwinds, China wound up eviscerating their Consumers instead of supporting their consumers, which I wrote about at length here:

Unfortunately for China, their Fiscal “Pain” won’t lead to any kind of “Pleasure” going forward because of the augmentative effects of their Short-Term Cyclical Property Bust Downturn constructively interfering with their Long-Term Structural/Demographic Downturn — not to mention the USD Wrecking Ball and high Oil prices as external headwinds to boot!

Horseman 3: Less Floating-Rate Dependence

The US Economy is also shielded by the “Structural Armor” of Less Floating-Rate Dependence from both Consumer and Corporate perspectives.

My good friend Alex Stahel quotes my other good friend Nick Glinsman here:

My own research from a year ago corroborates the 25% Floating-Rate Corporate Exposure, which is a key reason why I advocated a Fed/Treasury-engineered Bear Steepener instead of forcing Fed Funds up to 5.5%-6%:

The US Consumer, insofar as it is a Home-Owning Consumer, is also far less exposed to Floating-Rates than RoW:

Because of this, there are structural limits to how much other Central Banks can “Follow the Fed,” much less “Out-Hawk the Fed.” More on this later.

Horseman 4: Energy “Independence”

In this Geopolitical Mosh Pit of a world we live in, we should not be surprised that OPEC+, as the “Central Bank for Oil,” would act in its own interests to support the price of Oil. However, I’ve repeatedly labeled OPEC+’s multiple Supply Cuts thus far as "Premature Emasculation” of itself for the following reason:

Not only is Oil USD-denominated, because the US is such a large Net Exporter (and currently the largest Oil producer in the world), the US Economy is far less exposed to high Oil prices than the other Net Importers in the RoW:

China and Japan in particular are extremely exposed to the Twin Wrecking Balls of rising Oil and rising USD:

Because of OPEC+’s Premature Emasculation in support of higher Oil prices now before the Fed can declare victory in its Inflation Fight and because the US Economy is far less sensitive to the restrictive nature of higher Oil prices, the implication is that the Fed will stay Higher For A LOT Longer than RoW can handle and wind up crushing Oil Demand in RoW.

For a more nuanced view of Oil Fundamentals from someone who is Long-Term Bullish (you will see why I put Energy “Independence” in quotes) but very concerned in the Short-Term, read my Deep Dive post here (imho, it is far more balanced than a lot of Perma-Bull fare on the Internet these days):

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No Major CB Will Out-Hawk the Fed / Every Major CB Will Out-Dove the Fed

These thoughts about relative Economic Resilience have been percolating in my head for a long time now, and I coined the terms “Out-Hawk” and “Out-Dove” last year to express my view of the USD Wrecking Ball’s continued strength:

I wrote a piece at the beginning of the year about not counting out the USD Wrecking Ball, which was very out-of-consensus at the time with DXY close to 100:

I followed up here in March:

In June, I wrote a piece about how the USD Wrecking Ball has been hiding in plain sight, masked by EUR strength (and its overweight in DXY) but clearly evident in JPY and CNY weakness:

In my Ivan Drago piece from July, I stated that the Fed will likely break one or both of the following:

Despite the downward Labor revisions and recent softening in JOLTS data, it looks increasingly likely that RoW’s economies will break first before things get bad enough domestically to force a Fed Pivot.

The evidence of this started at the beginning of August in Latin America:

And now it has reached Europe, with this shocker from Poland — especially with 10% Inflation:

The economic data support my thesis, with recent PMIs for the US surprising to the upside and PMIs for the EU surprising to the downside:

Now that the EUR is starting to break down finally, we will soon see the USD Wrecking Ball strut boldly into the light:

Conclusion

Because of the aforementioned Four Horsemen of US Economic Resilience that cushion the effects of the Fed’s Monetary Depressants, the Fed will wind up breaking the economies elsewhere first and looks increasingly likely to become an Uneven “Distributor of Pain,” to borrow a phrase from Metallica’s “Harvester of Sorrow”: