a discussion around credibility, liquidity, and action
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I was on Trillionaire Mindset! A bunch of fun and I told a lot of not funny jokes
Note: somehow, I have developed a Recession series, so please read these works - if you feel like I haven’t addressed something, I likely addressed it in one of these!
Let’s discuss the vibes.
The inflation report came in super hot yesterday.
It was 9.1% headline inflation, which is psychologically a tough level - it’s also *very* high (remember, the Fed targets 2%) with a 1.2% print for June
It was also a broad-based increase - meaning that inflation is coming from everywhere, and doesn’t seem to have peaked yet.
It was also after a big 75 bps hike (now everyone is like !100bps!) which definitely takes it time to slow down inflation but the report was still… oof
With that being said, it is mostly coming from energy prices (driving ~50% of the print) as well as big moves in shelter costs (which are calculated weird and lag)1. Goods inflation is decelerating - but service prices, food, and energy are definitely not. Things are expensive. People are feeling bad.
Uncertainty: We have uncertainty - no one knows what the economy is really doing, or why. There are a lot of theories, but the key point is “what-the-heck”.
Uncertainty of Uncertainty: The certainty of uncertainty in the economy - how certain we are in being uncertain - has increased.
This is the second derivative of economic certainty, as Derek pointed out.
Even Powell said - “we understand better how little we understand inflation” - the certainty in being uncertain is increasing, which isn’t good.
Inflation creates uncertainty: The primary reason people are feeling bad *is* because of inflation, and just to hammer that point home - today’s print wasn’t pretty. It will get better, but this was an upside surprise.
And uncertainty questions credibility: This certainty in uncertainty - the idea that no one really knows what is going on (especially the Fed?) is driving a lot of the narrative. The Fed has full room to hike 75 - or even 100 bps now - but will that actually do anything? Can the Fed fix this through demand-side tools?
Eventually - if no one can buy anything, demand destruction will eat into inflation. But energy prices + food are sticky - and destroying people’s ability to buy that (simplistically speaking) might not be the best solution - especially as we see consumer leverage begin to tick up
People are worried that the Fed (1) won’t get inflation back down or (2) that they will rip rates right into a Recession, with a dedication to hiking even in the face of slowing economic growth.
The credibility of the Fed is predicated on a toolkit that might not work: The Fed has a hammer when really they need a power saw - their toolkit is designed for nudging demand, not increasing supply, which is what we really need.
The Fed can’t print oil or homes - all they really can do is say “hey stop buying gasoline” or “hey home ownership is the American Dream and we all know that’s been destroyed”.
Supply and demand vibe mismatch: The Fed are vibe destroyers - and we need vibe suppliers. That requires fiscal policy and the government to do something, which is a whole separate issue.
The Business Narrative
But the Fed drives narrative, and narrative is becoming increasingly negative right now. We can see this in microcosms. From the recent Beige Book that came out yesterday- “retailers' optimism looking ahead was somewhat tempered by concerns about inflation and a possible recession.”
Small businesses are feeling bad according to the NFIB survey - both in (1) expansionary plans and (2) expectations of higher sales, with inflation being the biggest worry for all of them - “with 34% of owners reporting it was their single most important problem”.
Lower sales tip more dominoes: If companies are worried about lower sales, they are likely to raise prices, as this paper from the NY Fed highlights. The paper underscores that it isn’t that companies are making more money (hmm) - but they are raising prices to try and battle inflation, which of course puts downstream pressure on consumers
But the labor market? There are also worries over worker shortages, with 50% of businesses reporting jobs they could not fill - which is counterintuitive to a Recession - people don’t hire into a downturn.
All of this is weird. Things are bad and good. Open jobs and higher wages relative to falling production and worries over declines in sales is… odd. It’s a strange juxtaposition. As Adam highlights -
Bryan Caplan @bryan_caplan
When is the last time the US brought inflation down 5 percentage-points or more without causing unemployment to rise by at least 3 percentage-points?There is all this talk that we aren’t in a Recession and that there is simply no way that we are because Look at This Data, but… what are we in?
What is a Recession?
I’ve written extensively about this (and i am sorry) - a vibecession, a disconnect between data and reality, people are really what matters, do we need a recession in the first place - and I feel like there will never be a conclusion to any of it (for right now, at least).
Dow @mark_dow
"It's basically stagflation, but with strong growth"Everything is fluffy.
When you have conflicting narratives on top of conflicting interpretations of narratives, of course things are not going to make sense.
A recession is technically a significant decline in economic activity spread across the economy that lasts more than a few months - but this varies (and people treat the 2 quarters of negative GDP growth as a religion2, just as a heads up). We had a recession in March of 2020 that lasted one month, so that 2Q thing isn’t even plausible. NBER, the council of elders that decides when Recession is Here, looks at (1) depth, (2) diffusion, and (3) duration of economic activity to make that decision - not just GDP metrics.
So for early 2020, they said “man, the economy is in the pits of hell - even though it’s only been a few weeks, we are in a Recession.”
And that checks out - the pandemic wiped out the metrics that they look at like real personal income less transfers, nonfarm payroll employment, real personal consumption expenditures, retail sales, and industrial production.
But NBER doesn’t really have any set rules on how a recession comes about - it’s mostly just the decline in economic vibes supported by data.
So maybe we aren’t in a Recession but we are in something.
But Everyone is Worried about a Recession
This once again underscores the importance of narrative and vibes.
Mortgage rates are dropping because everyone is worried about a recession
Oil prices fell because everyone is worried about a recession
Commodities are selling off because everyone is worried about a recession
The yield curve has inverted across some points, because everyone is worried about a recession
Wages are falling because of inflation, which definitely can make people feel like they are in a recession.
But ?
But when you dive into some of those metrics more, it gets even more confusing.
Oil, Jobs, and Misleading Data
Oil: Oil took a big nosedive, which Javier Blas wrote about - “Liquidity in oil market futures is very poor… several big producer-hedging deals… oil traders reported Wall Street banks buying put options for 2023 in large size… Don’t misinterpret one day’s price decline as presaging a relaxation of the pressure that’s pushed Brent up by more than 50% in the past year.”
So it’s a short termish combination of liquidity, market mechanics, etc. It’s not necessarily “Recession Incoming” - its just things being confusing.
Jobs: The economy added 372k jobs in June, unemployment was steady at 3.6%, and nominal wage growth grew, but was flattish enough not to spook a wage-price spiral. But the household survey was weak, which sort of negates the positives of the payrolls print. As Jason Furman highlighted -
“In fact, the disconnect between the reported job market and the economy is larger than we've ever seen in the post-World War II data… It is possible the economy is behaving very differently from normal. Or also possible that the data is wrong--output might be doing better than the headlines (see Gross Domestic Income which is stronger than GDP).”
So like okay yikes, right? It’s all market mechanics or… data being wrong…
But in general, it feels like the data is strong somewhat but parts of it are starting to noticeably weaken. It is kind of like rotted wood - it can hold up the house for a few more years (months?) but you better do something to ensure that foundation, and fast.
But how do we ensure the foundation?
The Fast and Furious Fed: The FOMC meeting minutes came out last week too, and the whole thing with that is the Fed is going to rip - they now have the blessing of a strongish jobs report and a super hot inflation report - they are going to move fast and furious to try and maintain credibility. That is the most important thing that they have - What the Fed Says.
Supply Recovery: We are starting to see recovery in supply - like graphics cards and the Home Depot skeletons - but clearly starting to see a pullback in consumer spend through retail sales. Supply is easing, but like?
Too Fast and Furious? But the worry is that the Fed is going to go full restrictive mode right into a slowdown - where we do see weakening company earnings, industrial metrics, and more - and it’s like - will the Fed hike into a Recession?
Fed Liquidity and Credit Risk: *But* the Fed is more than just a Nudger now - they are a Big Part of Markets. What does it mean to lose Fed liquidity? As the FT writes - Japan and Europe are both big buyers of US Treasuries, and as they go through their own crises, compounded by the Fed no longer backstopping the market - what happens to market functioning?
The NY Fed wrote a great piece on the selloff in treasuries - highlighting that a lot of the selloff has come from a rising term premium and the expectations of “tighter monetary policy” and rising short term yields - ending the paper with “it would take about seven years for investors to recapture losses accrued since the start of the selloff”. Yikes.
Ed Harrison highlights the risks in credit as leveraged loans, Europe, and EM countries - a lot of debt is at risk right now.
Energy is still a problem: Energy will have to be solved through more supply, which could happen as OPEC promises (hmm) to increase supply but still.
Nord stream, which is Germany’s big pipeline from Russia, is shutting down for maintenance and it’s a big shrug if Russia will choose to reopen it. The EU is shifting nuclear and gas to be classified as green energy because like, that’s what you do in an energy crisis. It’s a regime shift.
The Changing Economic Regime
Christine Lagarde said a few weeks ago, “I don’t think we are going to go back to that environment of low inflation”. This is a change in economic regime, which I will explore more on Saturday. But yeah. We largely aren’t used to the economic backdrop that we seem to be going into - our interpretation of reality has to shift.
But that begs the entire question - what is reality?
haha, come on, existentialist economics is excellent
But that’s kind of a valid question right now, right? Like when we think about what is happening with economic metrics, and the ~room for interpretation~ it becomes a lot of narrative and reality combining.
Things that are true are sometimes not true, but things that are not true are sometimes true, and it’s largely astronomically confusing.
The Vibes
The bottom part of the Vibecession environmental landscape is important - the combination of experience and evidence shaping expectations, which bleeds into perception and interpretation - ultimately shaping our narrative/world model. There is a theory that we are simply consuming way too much information. We simply are not built to be hearing all of this News, all of the time, and that totally shapes how we interpret the economy (please note, that a lot of this interpretation makes sense, but its compounded by the below).
Perception: Social media lets us mask our fear - we are just words on a screen and that gives us strength because its the closest that we will ever be to invisible.
So we rattle around online, discussing things, consuming information, formulating opinions, having our reality shaped and molded into some derivative of ourselves.
Interpretation: There is an element of nihilism - which many have written about with regards to our online selves. There is a lot to distrust. I think to the point about social media is that our online and offline selves are converging - and nihilistic tendencies are a huge component of that.
Evidence and Experience: It will also lead us to simply price out expectations in a way that makes sense to us based on experience and evidence - so for inflation, we’ve experienced mega-inflation, so why would it go back down? - and there doesn’t seem to be any tangible evidence of it especially after this recent print (which is also reflected in inflation expectations at large).
It’s a weirdness in vibes that is backed by this element of reality that ends up shaping our expectations. And finally - negating a lot of what I just talked about lol - there is also a really good point to be made - which AngelList made here - is that we are simply returning to normalcy. None of this is that weird. It’s just a reversion to the mean.
Final Thoughts
I like to use my newsletter as a place for economic analysis but also a place to discuss what it is to be human in these Circumstances because it can be so viscerally unexplainable to experience it all. It’s sort of like this -
How strange it is. We have these deep terrible lingering fears about ourselves and the people we love. Yet we walk around, talk to people, eat and drink. We manage to function. The feelings are deep and real. Shouldn't they paralyze us? How is it we can survive them, at least for a little while? We drive a car, we teach a class. How is it no one sees how deeply afraid we were, last night, this morning? Is it something we all hide from each other, by mutual consent? Or do we share the same secret without knowing it? Wear the same disguise? - Don DeLillo, White Noise
The economy is essentially a collection of human actions - how we spend money and how we spend time, the quantitative and the qualitative aspects of our existence.
Forecasting is the study of what is next, which can sort of be answered. But the answers are sometimes more questions. And I think that slight uptick at the end of a sentence tells us more about the economy than any report ever will.
It’s not just about narrative, but what the narrative itself drives.
As George Bernard Shaw said
The single biggest problem with communication is the illusion that it has taken place
This piece on Hivemind from gamerant stuck with me too
Non-humanoid hostile aliens are often depicted as a hive mind structure. From a narrative perspective, this allows each threat, no matter how different their capabilities or appearance, to pick up where the last enemy left off in combat. It's a built-in form of escalation, providing an in-universe explanation for the challenges raising in difficulty like video game levels
And finally, this from in the wilderless
The solutions to a problem are very very often not located in the same spot as the problem itself. A whole lot of issues only get solved by fixing up seemingly-unrelated stuff.
I will write a short follow-up to this on Saturday exploring some things a bit more.
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Shelter is broken into two different components: 1) owner’s equivalent rent and 2) rent of primary residence. With [Owner’s Equivalent Rent] Home prices are considered to be a capital investment NOT a consumption expenditure (of course) so OER is a rent proxy that reflects home costs. The index is based on a representative sample of rentals, and they interview people to determine weights for rental samples
There is a lot more that I want to write about the religion of financial metrics. I felt it necessary to share that with you.
Thank you, Kyla! You are the humanest humanist.
"The (complex) problem that gets resolved is the one that receives sustained attention." - somebody said.
Thank you Kyla! I loved "The Vibes" animation.