- 2023 reminds me of the “Everything Everywhere All at Once” movie. The most anticipated hard landing or recession did not happen even after a rapid 525bp increase in interest rates since 2022. Chair Powell said that the FOMC is “navigating by the stars under cloudy skies” in his August Jackson Hole speech about where the long-run “r star” (the neutral interest rate) will settle in this cycle.
- Many market participants were very critical about Chair Powell’s “transitory” comment regarding inflation during his March 17, 2021, press conference. In hindsight, the bulk of the inflation has been transitory. Much of the inflation was caused by COVID’s impact on the global supply chain. This exogenous shock caused significant fractures in the global supply chain and the transportation infrastructure. At the time, the demand for goods spiked as consumers had no ability to spend on and access services as the economy was shut down. This jump in demand for goods pushed prices of raw materials, finished goods, and transportation and delivery significantly upward. As the world learned to manage COVID and the supply chain recovered, goods prices began to fall, including energy and food prices. The drop in prices pushed the inflation rate (CPI) down from almost 9% in June 2022 to today at almost 3% (18 months). Although the Fed’s speedy rate hike of 525bp contributed to disinflation (i.e., the rate of price change from high to low), the drop in goods inflation was indeed transitory. If the Fed’s and the market’s current expectation proves to be right, CPI should be at or close to 2% by 2025. But the back and forth of the Fed policy rate hinged on every granule of economic data has been exhausting.
- 70% of the U.S. economy is based on the service sector, and consumers gradually moved away from buying goods to accessing services (revenge travel is one good example) during the past 18-months. As such, the prices for services have remain elevated for an extended period. This is partly exacerbated by the shortage and imbalance in the labor economy (in absolute numbers as well as a mismatch of skill and labor) and the rise in rental rates under a low supply of housing for purchasers.
- Most have not fully comprehended and thus underestimated the impact and the duration of the massive COVID related federal fiscal transfers on American workers, businesses, and local governments. Investors consistently underestimated the spending power and the willingness to spend by consumers. Additional uncertainties were created by unusual investor emotions, adjustments to an unprecedented policy path, and the application of old frameworks on new realities.
- Also, let’s not forget that the world is living with two regional military conflicts which could expand at any time to a wider theater and further destabilize the globe.
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