Good Friday Morning! Except to the Associated Press Stylebook, which stepped in it this week with a bizarre grammatical note: “We recommend avoiding general and often dehumanizing ‘the’ labels such as the poor, the mentally ill, the French, the disabled, the college-educated. Instead, use wording such as people with mental illnesses. And use these descriptions only when clearly relevant.”
I assure you, dear reader, that I’ll never need “the” to fully convey any disdain for the French. Or the British. @PourMeCoffee probably had the best response, “The Poor, The Mentally Ill and The French was my Booker prize winning novel of alienation, transition, and, triumph.”
This week, I’m jumping into the latest GDP report for Q4 of 2022 and walking through what the Federal Reserve might be thinking and where a recession stands – links to follow.
Where you can find me this week
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[01/23/2023] Fed Whisperer Says Federal Reserve Policy is Changing – Conservative Institute
[01/27/2023] Trump reinstatement on Facebook proves Elon Musk right – Conservative Institute
Data gets better for a “soft landing,” is that what the Fed wants?
We got our first look at Q4 GDP for 2022. The number came in higher than expected at 2.9% for the quarter. There were two immediate reactions I noticed in reading and watching the coverage. The first was: “What recession?” With growth near 3%, that pushes against notions of a looming recession.
The second reaction I saw was that “the headline number is good, but the report has weaknesses once you dig into the data.” There are merits to both points of view. I’ve written before about the tug-of-war between those who want the Federal Reserve to ease up sooner rather than later. Right now, there’s more evidence that the doves are correct than the hawks (and I tend to favor the hawks).
As both the Wall Street Journal and Bloomberg noted in their coverage, the “soft landing” crowd has the data on their side right now. Bloomberg summarized it like this: “For the Fed, which has hiked interest rates at the steepest pace in a generation over the past year, the data suggest that there’s still a path to what’s known as a ‘soft landing.’ That’s a scenario in which tighter monetary policy cools household spending and lowers inflation – but avoids squeezing the economy so hard that it ignites mass layoffs nationwide.”
The Wall Street Journal’s coverage described the report similarly: “The U.S. economy probably wasn’t as strong in the fourth quarter as advertised in the headline figure of Thursday’s report on gross domestic product. But it still wasn’t all that bad, and this year might not be entirely horrible, either.”
Let’s dive into some conflicting data points and see what’s happening.
A dive into the details of the GDP report provides a more mixed picture. Consumer spending was firm, growing at a 2.1% rate versus 2.3% in the third quarter. But there was a notable slowing in capital spending, with nonresidential private fixed investment growing at just a 0.7% rate. And the housing market continued to hammer the economy, with residential investment falling at a 26.7% rate—enough on its own to knock about 1.3 percentage points out of GDP growth.
Moreover, two often volatile categories boosted GDP last quarter. The first was inventories. They grew after contracting in the third quarter, and this restocking effectively meant businesses were producing more than they needed to merely meet demand. This boosted GDP growth by nearly 1.5 percentage points. The second was trade. U.S. exports slipped a bit in the fourth quarter, but imports declined by more. The narrowing of the trade deficit added almost 0.6 percentage point to growth.
Two key points are worth noting: the drop in capital spending and inventories. We’ll come back to the housing segment. Capital spending is significant because it’s a forward-thinking category. It’s where companies are investing resources to expand their business.
A quick definition of capital investment: “Capital investment is the acquisition of physical assets by a company for use in furthering its long-term business goals and objectives. Real estate, manufacturing plants, and machinery are among the assets that are purchased as capital investments.”
If you’re a construction company, capital investment could be purchasing new equipment. If you’re a restaurant, capital investment could involve buying property for locations or appliances to fill current spots. In short, it’s a company putting down money and saying, “we’re invested in the future and we’re taking these steps to do it.”
If capital investment is up, it suggests companies think optimistically. If capital investment is retracting, it could tell you the reverse. We’re witnessing most businesses pull back on capital investment – not all, but most.
The second item listed is “inventories.” Think of that as a retail business like Walmart, Kroger, Best Buy, etc., buying things for their stores and warehouses. Inventories have been incredibly volatile over the last few years. Companies either can’t get the goods they need to sell, leading to shortages, or they have so much of an item that consumers are no longer buying. Q4 featured a surge in inventories that didn’t match sales.
We could see inventories swing in the opposite direction in Q1 of 2023. It wouldn’t shock me if this happened because it happened in Q1 of 2022 too. Retailers are still looking for the perfect median of supply to meet demand because it’s a rapidly moving target across the board.
Housing is an excellent example of how prices stay steady despite the onslaught of bad news. For example, Fannie Mae is predicting a slow 2023 for the housing market because of high-interest rates and home prices, despite recent cooling on both. However, we haven’t seen a wholesale collapse here because housing inventory remains near all-time lows.
It’s a simple supply-demand calculation. Even with decreased demand for houses, supply has fallen too, which has helped keep higher prices afloat. That doesn’t mean we’re getting no drop in housing prices, there is some decrease, but the impact is minimal at this point.
A similar point to all of this is the employment market. Layoffs are happening, and we’re seeing them spread into manufacturing. But because employees are in short supply nationwide, people are finding a replacement jobs quickly. The layoffs are impacting more white-collar jobs, whereas we’ve seen little to no job destruction on the blue-collar side.
Stephen Meran wrote a great thread on Twitter going through one key thing right now: construction layoffs. With housing plummeting and inventory at all-time lows, you’d expect construction workers to get laid off. They’re not — construction employment remains near all-time highs.
Why are there no layoffs in construction? Meran points to the Infrastructure Investment and Jobs Act passed by Congress and signed by Biden in 2021. Meran notes that in 2023, $38 billion will be earmarked for construction projects. That jumps to $54 billion in 2024. He says:
In other words, I suspect builders are holding onto employees because the $$$ being spent by Uncle Sam on construction are going to start kicking in this year. Given a historically tight labor market where employees seem to have all the power, they’d rather hold onto the workers.
Why lay off your workers now if you expect real difficulty in hiring them back if building starts to pick back up, particularly for nonresidential construction?
If it sounds like I’m struggling to interpret the direction of economic data right now, it’s because I am. Indicators are pointing towards and away from recession. But as I wrote in my Monday Conservative Institute column, the Federal Reserve is in a transition period, and they’re struggling too.
If you’re a construction worker, this is a great deal. You’re staying in your job at a time when mass layoffs would be more likely. What about if you’re the Federal Reserve? Remember, the Federal Reserve wants unemployment to go up – they’ve said and projected this to reduce inflation and eliminate the wage/price spiral. How does the Fed read this kind of data?
There are distinct signs the economy is slowing. It’s easy to find those data points. It’s also uncomplicated to find good economic data that suggests we’ll avoid a recession.
The multi-trillion dollar question is this: what does the Federal Reserve count as a victory? Is getting lower inflation reports enough? The Fed has pointed to wanting to eliminate inflation. If the Federal Reserve eases rates right now, most would expect demand to go back up and inflation to run higher.
How long does the Fed keep rates higher to prevent inflation from going back up? No one knows the answer. Markets are betting that the Federal Reserve will pivot this year and eases rates. The flip side of that argument is Lawrence Summers, who continues to argue for caution at the Federal Reserve:
Former Treasury Secretary Larry Summers is starting to grow more optimistic about the U.S. economy and the Federal Reserve’s ability to stick a soft landing, according to a recent interview.
He told Bloomberg on Wednesday that it’s a good sign inflation is starting to cool down even as the job market remains resilient.
“I’m still cautious, but with a little bit more hope than I had before. Soft landings are the triumph of hope over experience, but sometimes hope does triumph over experience,” Summers said.
“We’ve seen some slowing of inflation indicators. At the same time we’ve seen continued strength. That’s gotta be what we all want to see,” Summers said on Wednesday.
But the inflation fight is not over, and Summers believes the Fed will need to continue hiking interest rates. The market currently expects a Fed terminal funds rate of about 5%, which would require two 25-basis point rate hikes in February and March.
“I still think it’s going to be hard because we need a substantial amount of disinflation that goes beyond volatile components receding,” he said. “You have to recognize that the figures are better than somebody like me would have expected three months ago. It’s still a very difficult job for the Fed, but the situation does look a bit better.”
Note what Summers says at the end: “we need a substantial amount of disinflation.” That’s not a thing you’ll see talked about much. Most of Wall Street is focused on lower inflation reports – but disinflation is an entirely different animal. After all the price increases we’ve seen, most Americans would welcome some disinflation.
But what is the Federal Reserve aiming for? We know they talk about a long-term 2% inflation goal. But do they also strive for some disinflation to even out the scales? It’s impossible to say. But we do know from reporting the Fed is increasingly divided on what to do for the rest of 2023.
I’m still on the recession side of this debate. I’m sticking with the call I made last year. But I admit the hard data makes that call harder to hold. We’ll see where things head throughout 2023! If the data says there is no recession, I’ll admit defeat. If not, hopefully, the recession isn’t a bad one.
My main concern is similar to Summers, though. If the Federal Reserve pauses here and follows what markets say, I think inflation will pick back up. Just because the inflation rate has lowered doesn’t mean the underlying problems are fixed. When does the Fed say things are fixed, and they need to pivot to lower rates? I don’t know, and I don’t suspect they do, either.
Links of the week
Unredacted NIH E-mails Show Efforts to Rule Out a Lab Origin of Covid: In early 2020, top scientists told Anthony Fauci they were concerned that SARS-CoV-2 appeared potentially “engineered.” Here’s a look at what happened next. – Jimmy Tobias, The Nation
Taxes: Here are the federal tax brackets for 2023 vs. 2022 – Yahoo Finance
Secrecy Is for Losers: What Biden’s classified document scandal reveals about power in America – Jacob Siegel, Tablet Magazine
Biden Document Discovery Doesn’t Add Up – Greg Orman, RealClearPolitics
The False Promise of Net Zero Emissions – Glenn Loury and Steven Koonin
The scariest part of the debt ceiling impasse: Washington isn’t scared – Ramesh Ponnuru, Washington Post
Veterans of the Obama-era debt ceiling standoff on the current one: We may be doomed: Financial experts and political operatives experiencing debt ceiling déjà vu fear this time around, the ending could be catastrophic. – Politico
Gallego’s early Sinema challenge squeezes Senate progressives: Liberals in the upper chamber who find the Independent incumbent frustrating have to decide if it’s worth supporting a challenger while they still need her vote. – Politico
The Institutional Hostage Crisis: America’s leaders have ceded their moral authority to the mob. It needs to stop. – Christopher F. Rufo, City Journal
‘Frank Lloyd Wright: The Man Who Built America’ Review: An Architect for the Ages: Wright’s celebrated work, from homes to churches to the Guggenheim Museum, is the focus of a documentary on Acorn TV. – WSJ
Twitter Thread(s) of the week
Satire of the week
Abraham Lincoln Found With Classified Documents In Coffin – Waterford Whispers
Thanks for reading!