Goldilocks is transitional; it’s what’s next that will represent the next major macro theme
Ever since the 30 year Treasury bond yield (one ‘top-down’ macro tool NFTRH uses to gauge the environment so that we may invest in, speculate upon or avoid certain situations, accordingly) broke its Continuum of pleasantly declining long-term Treasury bond yields, macro nerds have been called to task in order to correctly interpret the forward backdrop that this break implies. The note at the upper right of the chart asks the key question.
In Q4, 2022 we began forecasting a Goldilocks (inflation not too hot or cold) style recovery in financial markets to be led by the Tech sector due to the over-bearish sentiment at the time, the mid-term election cycle, a projected of easing inflation signals and certain signals that traditionally coincide with or precede oncoming bear markets, that were not in place in 2022 (e.g. the yield curve still flattening, 2yr yield not divergent from the 3 mo. T-bill yield).
Well, a Tech-led Goldilocks came and to this day endures by measures like the ratio of Tech stocks to broad stocks (QQQ/SPY). Also growth stocks (IGX) are still leading value stocks (IVX).
But what is now important is not what has been since Q4, 2022. By now everybody long-since has the memo. What is important is where we are going, because forward gains and proper risk management demand a forward view based in reality, not dogma, bias or media-served robo analysis (and eyeball harvesting). Here are the three options for what is ahead, assuming I am correct that Goldilocks will not endure (not so humbly, I am).
Deflation
The simple fact that the battle against the inflation that the Fed itself printed in 2020 rages on, may bring about the eventual demise of inflation as the Goldilocks disinflation of the post-2022 phase progresses straight to a market liquidation under the pressure of tight monetary policy. This is our Fed Chief Quixote tilting at the inflation windmill with extra verve because he knows he was primary in creating it and what its economically corrosive, even destructive potentials are.
Let’s take a look at one major signal that has stretched the elastic band of risk excessively. The last two times the Fed’s monetary policy (3 mo. T-bill, Fed proxy) notably exceeded the bond market’s signal (2yr yield) deflation scares followed. If we are to extrapolate what has been to what is today, the pressure of the Fed’s tight policy, not to mention the spike in long-term yields per the Continuum chart above would result in a hard failure of the 2020 inflation > 2023 Goldilocks into a deflationary liquidation.
I continue to give the deflationary scenario solid odds of playing out as the next phase, with a slight edge over the next option. This could be very temporary before the next inflationary episode or it could go beyond previous deflation ‘scares’.
Stagflation
Enter, the Stag. This is where the economically corrosive effects of inflation persist, the bond market continues to battle it through rising interest rates (ref. the Continuum above), but the resolution is not a deflationary cleansing but instead, an ongoing phase of a weak economy, impaired by persistent inflationary effects. Again with respect to the Continuum, might the bond market, after all those decades of inflationary policy slop licensed by those same decades of disinflationary signaling simply be telling us that such policy has hit a saturation point? So much slop shoveled onto the pile and now it’s starting to just roll over and topple.
Wednesday’s inflation data showed a second month in a row of an annually increased consumer inflation rate. OPEC+ and its oil price rigging has much to do with this.
The core inflation rate, which strips out energy (oil) and food prices continues to decline.
Even though the prices of agricultural commodities have generally been in decline, the prices being gouged upon consumers within the supply chain are not helping tamp down headline inflation. This appears to be Don Quixote’s greatest backward looking enemy, perhaps because he knows an election is upcoming for an administration that has staked its reputation on fighting inflation (while shoving inflationary fiscal policy into the economy out the other side of its orifice). This appears to be the makings of the Stag case.
Yet the rate of “sticky” price inflation is actually decelerating. While still aloft nominally, a decline in these prices would start here.
I give the Stagflationary view near equal odds to the deflationary view.
Crack-up Boom
The old Ludwig van von… a Crack-up Boom would be viable if the markets disregard the Fed’s current state of hawkishness and pretense of sound monetary policy and an oncoming Stagflation eventually morphs into an all out inflationary panic.
In this case the interpretation would be that the credit expansion, systematic through the decades of the Treasury yield Continuum, finally resolves not in a deflationary liquidation but instead, an excessively intense, even hyper-intense inflationary panic. This is where you hear stories about Wiemar Germany and wheelbarrows full of paper money for a loaf of bread.
This option, which I do not (yet) favor, would end the system. It would have people wishing for the good old days of the policy induced boom/bust (inflation/deflation) cycle.
That cycle was most prominent from 2000 to this day as the age of an alternately boomed and busted stock market bubble really kicked in. But now the blessed secular downtrend in long-term yields that kicked off in the 1980s is done. Change, probably measured over the next several years, is at hand.
Bottom Line
A profound change has come upon the macro. A nearly four decade long trend is done, kaput. A system saturated with inflationary policy that was given license by the disinflationary signaling of the bond market is no more.
Now the signaling is inflationary and it is going to resolve into a deflationary liquidation of the excess or an ongoing inflationary and economically corrosive Stag, which one day could resolve in a deflationary climax (unlike the deflation scares of 2001, 2008 and 2020 that were ably attended to by central banks with one primary tool, inflationary rescue policy) or a hyperinflationary one. Either of which will likely end or radically change the system.
As to those inflationary tools, one image eternally sticks in my mind. The Hero, emblematic of inflationary policy to the rescue. I and a good number of you could see it for the blight it was then, and one day so too will the public caught in the savage changes to come.
Meanwhile, we as individual investors, speculators, financial and social refuge seekers, etc. had better be right in our interpretations over the coming years because never in my experience (which has obviously been within the scope of the Continuum’s decades) have the options been so different and also so viable.
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Great work as always Gary. You probably encountered this before but I find Russell Napier’s musings on the future interesting: https://themarket.ch/interview/russell-napier-the-world-will-experience-a-capex-boom-ld.7606 Essentially, the govt will control the outcome. 4%-6% annual inflation to reduce debt burden.
I skimmed it and will read the rest later. If I read him correctly, he is saying “fiscal” inflationary policy as opposed to the Fed’s “monetary” inflationary policy (currently in mothballs). I agree with that premise and as you know have been mentioning the fiscal side of the equation in NFTRH. It’s super interesting, viewing this push/pull tug of war between monetary and fiscal. Thanks for the link.
John, I just finished the article and I have to say it is brilliant. I don’t necessarily agree with everything RN said, but most of it is completely viable. The way he lays it out implies less volatility (social and financial) than I think we will encounter in the next few years. But overall, that is one hell of a sound thinker. I’ve heard the name, but never knew who he was.
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I am a chart guy who has evolved my charting in combo with macro data to try to detect the very things that he lays out. It’s stunning how many of the concepts rhyme. Thanks again for that link. Highly recommended.
John, thanks for the Napier link.
“… the power to control the creation of money has moved from central banks to governments.”
Fedgov’s response to covid was the pivot and proof of the turn Napier sees: loan forbearance, stimulus checks, special tax refunds, etc etc etc, with more to come — these are *direct* monetary transmissions *directly* from fedgov to consumers, bypassing central banks and the banking system. The Commies in Tubman DF will print like there’s no tomorrow unless *stopped*.
But the question is, who stops them, a financial market rebellion (in progress w/ yields) or a rebellion with live people and weaponry?
Another key consideration is that the Fed always inflated under cover of supposed deflation. The question is, will the government have the same paranoia about public perception or will they simply buy the public off again. In other words, a deflation scare sure would scare up more make work programs. That’s what we’re running on now, since the Fed abdicated. Does the government give a flying fuck about perception??
“the question is, who stops them”
Napier says they can’t be stopped, government “wins,” central banks are “impotent.”
Maybe, maybe not. Very *real* tension exists currently between J. Powell at the Fed and J. Yellen at Treasury.
Also, some kind of anti-woke thermidorian reaction against the radical revolutionaries may be brewing off stage.
(A comment thread is probably not the best place to get into this, so … we’ll just have to wait to see what happens.)
“Does the government give a flying f**k about perception?”
My read of the past six years, especially the past two years, heck the past two months — no, the regime, er govt, doesn’t give a crap about public perception.
Why can’t we have both? Meaning stag into 2023 and abrupt change to deflation sometime in 2024. Deflation triggered by credit event will occur when critical mass of borrowed money at ZIRP or near needs to be refinanced at 5% or so.
I think that the Stag, much like Goldilocks, will be transitional. The question then becomes does it all just come apart at the seams into a down the drain deflation or an ever more intense inflation with government fighting deflation tooth and nail? As long as the people have confidence in the conventional way of doing things and the current system, they (gov’t) have the power. That is why Trump was so disappointing to me. We had a chance to have a real insurgent in there and instead got a cartoon character, cultural icon.
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Anyway, I would not discount von Mises if the government becomes desperate enough in trying to inflate its debts away.
Stag, then von Mises extremely unlikely. Still very unlikely, but more realistic imho, is that crack-up boom happens after one of two: 1. Loss of war with irreversible shift in global power, (chances between 0 and -0). 2. Internal unrest, unraveling of the social contract – people lose jobs, get angry, establishment forced to bribe peasants. Actually this has a chance greater than zero. But in this, still unlikely, case deflation comes first. Most likely, imho is deflation followed with another business cycle. Although with leaderships like current (I don’t mean just figureheads but generally quality of political establishment – both sides), anything has a chance of greater than 0.
“anything has a chance of greater than 0″… it’s Wonderland, after all. That’s why this site and service are so named. It’s all on the table. But IMO the path of least resistance is interim deflation. That is the license authorities have used in order to inflate.
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Interim though. Authorities will not stop inflating by various means until they are forced to by the bond market or the pitchfork. The problem being the 2022 rupture of the secular trend in L/T bond yields. It’s going to have some effect on what has been inflationary business as usual for decades. Logically, it indicated intensified inflation problems. But again, I agree about the chances of an interim deflation scare to kick the whole thing off.
Janet Yellen is a MMTer. What’s odds do you give of Yellen’s delivering UBI, bleak reparations, student loan jubilee, blue state “sanctuary” bailout, and much $worse post-Our Democracy 2024? Some combination, I say, is 99% certain. Where’s the “money” coming from to pay for it all?
“… or the pitchfork.” They’ll be no pitchforks. If I learned anything since 2016, only lefty is allowed to protest in America.
Yellen is an MMTer and TMMer… total market manipulator. It’s a cult. Cue my Outer Limits shtick, except that the government is fiscally picking up where the Fed left off. “We will [try to] control…”
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The issue I felt in my gut from 2016 on is that the irate public picked the wrong pitchfork. I felt like Trump was a cartoon character spouting what the public’s common denominator wanted to hear. He was not a real insurgent. That was a crying shame. In a society full of sincere and intelligent people who want to do the right thing, we sadly have ignorance on a mass scale and that ignorance elects utter clowns on both sides of the aisle.
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IMO its a cultural thing. Maybe how societies end, through sloth and hubris. Dumbing down collectively until the thing just wheezes and rolls over. Both sides of our supposed political arena are disgusting to me. Government is government and it is getting more insensitively intrusive, regardless of who’s in there.
On unrelated matter, oil up, gold down, gold stocks up. Banksters and plunge protection manipulate gold stocks up! :)
LOL, Armen. Perfect!
“… the irate public picked the wrong pitchfork.”
Was there a better or correct pitchfork on offer in 2016?
“In a society full of sincere and intelligent people who want to do the right thing, we sadly have ….”
Not ignorance, instead no leader.
“Both sides … are disgusting to me.”
You’ll get no argument from me. That’s why some of us call republicans the “Vichy OP,” that is, the Vichy Opposition Party.
A) I’d have taken any Republican who was rational and focused on things other than him/herself. B) Non-leaders have been elected largely by ignorance, IMO. Call me elitist if you want, but I am anything but that. I am fatalist and have viewed society as degrading my entire life. Not ignorant. A lunatic maybe. C) What does Vichy mean?
“What does Vichy mean?”
Refers to the administrative regime located in the resort town of Vichy, France, during Nazi occupation.
They rolled over and said please sir, may I have another?
We are at a very similar time just before the tractor was invented at the beginning of the 20th century. Back then, half of the work populace was working in the agricultural sector and most of them lost their job due to this invention. This was what caused the great depression. It took the labor market basically 2-3 generations to re-balance itself.
That being said, there will be plenty of attempts to inflate before we get there. But our outdated financial system combined with the tremendous productivity gains ahead will eventually result in deflation.
“rolled over and said please”
Kind of. As vichy opposition, current-era republicans serve the uniparty by “conserving” every left-wing “innovation.” “Whaddya mean, we’ve always been for wide-open borders!” Give it a year or two. Think back over the decades on all the “progress” none of us wanted, didn’t ask for, and certainly never voted for — all these progressive innovations are now standard-issue bullet points of the GOP platform.
Anyway, trees don’t grow to the sky, only ’til they fall over.
Food for thought: Any discussion of how the future of our economic landscape plays out must address the two different types of ‘dollars’ … electronic dollar credits and foldable cash. When viewed in this manner there could easily be hyper-inflation of electronic dollar credits and hyper-DEFLATION of the very scarce paper money that simply cannot be printed fast enough.