Re: Inflation/USD/Oil - The Return of PP and the Coming of PPPP.

Pusillanimous Powell is back, and he's about to make a Policy Error -- not from being "Too Late" but being "Too Early." This post covers ramifications of Pusillanimous Powell's Premature Pivot - PPPP.

I had a friend who used to call JPOW “P*ssy Powell” given his needless juicing of the Post-COVID economy in 2021 with continued massive QE on top of massive Fiscal Support — long after the economy had not only recovered but after asset bubbles had formed all over the place. Remember NFTs?

I have a less pejorative moniker for JPOW now but the spirit remains the same — “Pusillanimous Powell” (PP for short). I like the versatility of this moniker, because you can still choose to emphasize the first two syllables if you’d like and also because the alliteration works for “Premature Pivot” as well.

Pusillanimous Powell is back, and he's about to make a Policy Error -- not from being "Too Late" but being "Too Early." This post covers ramifications of Pusillanimous Powell's Premature Pivot - PPPP.

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Stan Druckenmiller famously called out PP’s 2021 Fed Policy in May, 2021, and his comments made me think of a Mental Model for how PP’s excess liquidity was “storing up” Inflation in “Inflation Capacitors.”

The strong Oil Bull Market of 2021 (caused by a myriad of factors but certainly exacerbated by PP) led me to a very non consensus call at the end of 2021, that Inflation led by Oil would cause the Fed to reverse course and Out-Hawk the world and create what I coined as the “USD Wrecking Ball” that would discharge these Inflation Capacitors (which occurred in 2022 only to be recharged again by extreme Fiscal Profligacy).

Fast forward to today. After two years of a hard-fought Inflation Fight (hard-fought because he was stymied every step of the way by The Four Horsemen of US Economic Resilience) and the Reflationary consequences of the ill-timed December Rhetorical Pivot (which I wrote about in “Dipping Dots”), I thought that perhaps PP had finally recognized that the current bout of tighter monetary conditions is actually the CURE to past Policy Errors of being too accommodative. I thought that maybe, just MAYBE, he had learned his lesson and morphed into MP:

Alas, that was not to be, because at Jackson Hole, JPOW’s inner PP revealed itself yet again, as Bloomberg economist Anna Wong points out here:

I’ve been a stalwart H4L believer these last two years and have (correctly) discounted all past market pricings of the Return of PP — until now.

I believe him this time around because there are just enough points of Macro Confusion now that make JPOW think his Dual Mandates are in conflict (when I believe they are not), paving the way for his inner PP to shine through.

As a result, I think PP is about to make a Policy Error in ushering in PPPP.

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The Case Against a Premature Pivot

I do not think the Fed’s Dual Mandates are in conflict yet, despite the recent Labor Revisions. I had previously thought they might come into conflict by end of 2023, but the Fiscal Levitation has surprised everyone.

On August 15, I hosted a Twitter Space to make the case that being “Too Early” would be the true Policy Error — not being “Too Late” as the Deflationistas suggest.

I enlisted the expertise of 3 planned panelists and 2 ad hoc panelists:

Danny Dayan

Nicholas Glinsman

Althea Spinozzi

Michael Green

Alex Stahel

ICYMI, here is the recording: The Case Against A Premature Pivot

In this post, I cover my bullet points for why I think the PPPP will be a Policy Error, many of which I made in my opening missive. I encourage you to listen to the recording to hear the other panelists’ perspectives as well.

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“Too Late” Is Exactly What We Need

Many voices are clamoring for aggressive cuts, claiming the Fed is “Too Late,” to which I say:

• “Too Late” is exactly what we need!

• For the last two years, the Fed has been working hard to blunt Aggregate Demand only to be countered by the efforts of Fiscal Spending and Tsy QRA Games.

• Recent Labor Revisions notwithstanding, the US Economy is still TOO STRONG for a Premature Pivot to NOT Reignite Inflation:

  

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Credit Is the Canary, and the Canary Is Singing

There is simply no need to panic when CREDIT is not only extremely well-behaved but also available in abundance — even during the YCT Panic week of 8/5/24.

I pointed out the complete LACK OF CREDIT FEAR repeatedly during that week:

• I recently explained how a Bond is akin to a “Short Put” on Firm Assets in my Merton post, and since Credit is the largest “Short Put/Short Vol” Asset Class, its benign state means that a Premature Pivot would do more than just REMOVE Restriction — it would actually ADD Stimulus:

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Reasons for Macro Confusion

Conflicting Macro Data seem to be confusing BOTH Inflationista and Deflationista camps right now:

• There’s been “something for everyone” in the data.

• For every bearish data point, I can give you an opposing one that shows that the Economy/Inflation might be inflecting higher. My fellow panelists gave many of these examples as well.

  

  • If you’d like to see examples of economic data that seem to be inflecting higher, I have a data dump at the end of my USD Wrecking Ball to USD Pickleball post.

I believe the Macro Confusion stems from several factors:

• As we get closer to the top of a LT Cycle, economic forecasts can become wildly divergent, as folks make Linear Extrapolations off of ST oscillations. I wrote about this forecasting pitfall in my “Surfing the S(e)ine” post.

• Recency Bias really compounds these Linear Extrapolation errors, imho.

  

• I believe the trajectory of the LT Cycle is still positive despite the Fed’s efforts to slow things down, because it keeps getting prolonged by The Four Horsemen of US Economic Resilience (especially Fiscal) + Tsy’s QRA Games:

• This “Vodka Red Bull” Dynamic I’ve often referred to is creating all kinds of distortions and certainly is a key source of Macro Confusion:

  

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Bifurcated Economy

I believe that there are Structural as well as Cyclical (Policy-Driven) factors behind our current Bifurcated Economy.

• Not only is the “Vodka Red Bull” Dynamic confusing, it is also self-defeating and therefore likely to cost the taxpayer more in the long run, as this Push/Pull between the Fed and Fiscal/Tsy drags the Inflation Fight out for far longer than it otherwise should:

  

• The The Four Horsemen of US Economic Resilience create “Uneven Distributions of Pain” (note the double Metallica reference), which result in the Bifurcations I’ve spoken at length about:

  • Within US — Haves vs Have Nots

    • Individuals

    • Corporates

  • Between US & RoW

• Most of the Doomsday Data seem to be coming from specific Have Not segments, but the Aggregate Economy is doing just fine.

• See the posts below about spiking Credit Card Delinquencies and then recall what I said about Credit in the aggregate:

• Here is a chart of the HYG (High Yield ETF). Does that look like a sign of Restrictive Policy to you?

• Unfortunately for the Fed, it has a BLUNT TOOL and not a Surgical Knife with which to enact Monetary Policy. If it chooses Monetary Policy that alleviates the stresses of the narrow Have Not subsegments of the economy, it will also BOOST the Aggregate Economy and REIGNITE INFLATION — the exact OPPOSITE of what it has been trying to achieve over the last two years.

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When Inelastic Supply Meets Demand Boost

I also believe that many Aggregate Supply Curves are still INELASTIC, again due to a combination of Structural/Geopolitical/Demographic/Policy factors.

This is critically important, because there was no such confluence of Supply Inelasticities during the last several DECADES of quiescent Inflation.

• Oil - driven by Geopolitics and KSA’s Unilateral Cuts

• Freight Rates – driven by Geopolitical Risk in the Middle East

• Manufacturing Capacity – driven by Geopolitical choice of Near-Shoring

• UST Bonds – driven by Tsy’s deliberate QRA Games to restrict supply of Duration

• Housing - driven by Structural Undersupply

• Labor – driven by Demographic Undersupply + Politics (recent Wage/Price Control rhetoric reminiscent of the 1970s)

What happens when Inelastic Supply Curves are met by a Demand Boost?

Even a modest Demand Boost hitting an Inelastic Supply Curve can result in disproportionate and material Price Inflation.

I am most concerned about Housing and Shelter Inflation, because not only are there nonsensical Demand-Boosting proposals being floated to “help affordability,” a Premature Pivot would do the same by lowering Mortgage Rates:

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Weaker USD Is Also Stimulative

The PPPP (depending on how aggressive PP is) can also lead to a Weaker USD.

It already has:

But can the USD Wrecking Ball truly downgrade to the USD Pickleball without Inflationary consequences? I don’t think so.

In my USD Wrecking Ball to USD Pickleball post, I outlined three different paths to a Weaker USD but highlighted only ONE Golden Path that would likely NOT Reignite Inflation — a Geopolitical “Oil for Security Guarantee” deal for KSA. Even so, Low Oil is just a necessary but insufficient condition for a return to quiescent Inflation.

In Battle of the BADS, I took you around the world and walked through the various Central Bank Dilemmas in dealing with a US Economy that’s stronger than RoW.

Because the US Economy remains stronger than all of the other major world economies, it behooves RoW’s CBs to OUT-DOVE the Fed. That has NOT CHANGED despite the Return of PP.

If the Return of PP embarks on this Premature Pivot, depending on how aggressive he is, it could NEGATE the Equilibrating Mechanism of a Strong USD (needed to correct economic imbalances) and potentially usher in a round of Competitive Cuts since no CB in RoW wants to be Out-Doved by the Fed.

Result: RESURGENT INFLATION.

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When the Bond Market Takes Over the Fed’s Job

What happens if I’m right about the Return of PP ushering in a Second Wave of Inflation?

It depends on how aggressive the PPPP is and whether or not PP is willing to course-correct.

To see what happened historically when the Fed was NOT willing to change direction, I went back and studied the Bear/Bull Steepening during the Stagflationary 1981-1982 period.

This is the month-by-month Yield Curve change (ex-FFR for some reason) during this period. What a mess.

As you can see, the Rate Volatility all along the YC makes this period challenging to analyze, so I entered the data from each month, filled in the historical FFRs, and created this table and chart, which shows the time evolution of key Rates along the YC as well as CPI change:

Observations of the 1981-1982 Bear/Bull Steepener:

• Rates/Inflation were MUCH higher then but the RELATIVE changes are what interest me.

• Aggressive Rate Hikes by Volcker to stamp out Inflation had taken FFR to a peak of 19-20% by December, 1980 and had plunged the US Economy into a severe Recession with double-digit Unemployment by 1981.

• Although Inflation was still around 12%, the Fed’s Dual Mandates were TRULY in conflict then — UNLIKE now.

• Still, the Fed felt it had no choice but to cut, and as the Fed began its Premature Pivot, the decision seemed justified...for about 5 months before Inflation began to inflect higher again.

• In spite of this, the Fed was determined to continue cutting, and Rates all along the YC sniffed this out to be a problem only 3 months after the first cut and began to BEAR STEEPEN.

• The Fed continued to cut despite the Bear Steepening and Resurgent Inflation, which then resulted in a SEVERE Bull/Bear Steepener by Q3’81 that really crushed the economy and asset prices.

• When the Fed couldn’t do its job anymore, the BOND MARKET took over.

I think the odds are high that a Premature Pivot now leads to either Whiplash Monetary Policy (had to throw in a 3rd Metallica reference) and a return to HIKES and/or a Bear/Bull Steepener by 2H’25.

Sad But True (sorry).

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Conclusion

I think we are entering a Stagflationary ANTI-GOLDILOCKS environment where:

• Growth will be just weak enough that sales and earnings targets by highly valued Equities will be challenged.

• Growth will be just strong enough to make any goosing of the Aggregate Demand curve juice Inflation — especially given the state of Inelastic Supply Curves.

• I have no quibble that GDP Growth is cooling; what I quibble with is whether it’s cooling ENOUGH to prevent RESURGENT INFLATION if the Fed stops short and reverses course at the 10-yard line.

• The Return of PP is a worrisome development not only because it potentially prolongs the Inflation Fight but also because it is so difficult to position for given the inevitable crosscurrents of Macro Confusion it sows.

• When you consider the history of the 1981-1982 period when the Fed TRULY had a conflict between its Dual Mandates, it boggles the mind that Pusillanimous Powell wants to eradicate all semblance of NORMAL BUSINESS CYCLES, given that the current Macro backdrop (especially Credit) is too sanguine to risk a Premature Pivot.

• Remember that it took a SEVERE Recession to finally break the back of Inflation in the early 80’s. PP doesn’t seem even willing to tolerate a Mild Recession.

• Given the Bifurcations in the economy and the INABILITY of the Fed to surgically alleviate stress for certain Have Not subsectors without also Reigniting Inflation for EVERYONE else, the PPPP recalls yet another Mental Model for what I think could come next for Inflation readings:

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