Our previous articles and analysis on Inflation:
March Newsletter – Inflation Nation
August 22, 2022: Idiots and Inflation
December 2022: Inflation is getting worse, and the Taylor rule
April 2023: The Paul Volcker Shock 2.0
In the first week of September, we are scheduled to publish Payment Shock - The Economic Impact of the Resumption of the Student Loan. Stay tuned.
Inflation and recession go together like love and marriage. During the courtship, the money and favors flow freely, and when finally wed, breaks are applied to the spending, and favors become responsibilities.
Unicus has written about both several times, and we have been very accurate. Did we get pushback from our readers and clients? Yes, we did, and we respected and enjoyed every bit of the pushback. Much of that pushback came from those who were desktop analysts. They were diligently pouring over numbers from the Fed, lenders, real-estate sales, and the CPI. From what they were reading, the US would be OK; a “soft landing” was in the works.
Where did we differ? We differed as we did not look back to predict the future we looked forward. We spoke to inventory managers, shipping companies, debt managers, bond dealers, credit card companies, vehicle repossession companies, property managers, and the bankruptcy courts.
Let’s first look at those things we see and know to be inflationary.
From the Atlanta Federal Reserve, a chart of the Taylor rule.
The chart shows that the Fed Funds rate required to stop inflation is between 6.54% to 7.13%. The current Fed Funds rate is from 5.25% to 5.5%. Thus, to stop inflation, we require a Fed Funds rate that is ±35% higher than today.
From the NY Federal Reserve
Credit card balances increased by $45 billion, from $986 billion in Q1 2023 to an all-time high of $1.03 trillion in Q2 2023, marking a 4.6% quarterly increase. Credit card accounts expanded by $5.48 million to $578.35 million. Aggregate limits on credit card accounts increased by $9 billion and now stand at $4.6 trillion. That’s up from the first quarter of 2023’s record number, leaving the balances due at the highest since the New York Fed began tracking in 1999.
What does this mean? It means the populace has been using credit cards to bridge the gap between their earnings and the cost of living. Note the acceleration of debt concurrent with inflation spiking.
Credit card delinquencies over 90 days have swelled from 2% to 5% in two years. What happens when you miss a few payments – your credit card interest rate gets jacked up to 29.99%. It is all automated. No one at the credit card companies is thinking or cares. When this happens, the credit cardholder goes from wanting to settle the debt to a “screw you” attitude. But wait, it is going to get worse.
When you get a credit default cascade, you default on student loans, vendor–specific cards like gas cards or department store cards, bank credit cards, auto loans, then rent or mortgage.
Student loan payments have been in abeyance until October -so we will not know for some time how bad that is going to be, but from all reports, the student loan debtors consumed the advantage of having a little extra money on hand. Instead, they have incurred even more consumer debt. So, the first in the default cascade for 2023 are going to be vendor-specific cards.
According to Reuters news service, “Macy's executives disclosed on Tuesday that rising delinquencies cut credit card revenues to $120 million in the second quarter, down $84 million from the previous quarter. While Nordstrom's credit card revenues rose 10% in the first half of this year, it could "result in higher credit losses in the second half and into 2024."
Auto repossessions are up on average but are up a great deal more in those cities and states where life is more expensive. Also, the volume is up at car auctions, and the average price per car sold at the auctions is down. While this may not be seen on auto finance companies' public financials until Q3 results are published in November – it is happening now.
The chart shows inflation is coming down – for now. Why is not debt coming down? That is because wage growth has lagged well behind inflation for over two years. The average consumer cannot keep up with inflation running higher than wage growth – so charge it.
What else is driving inflation? The Federal Government Spending is the prime driver of inflation.
Please look at the chart carefully. Inflation became a serious problem when the US spent too much in the late 1970s and early 1980s – remember the 19% Federal Fund rate? To address inflation, the fed fund rates were raised to temper demand and caused two back-to-back recessions. Today, US spending is greater (in real dollars or as a percent of GDP) than the spending that caused inflation in the late 1970s and early 1980s. The delta between revenue and spending is how much the US debt has had to and will grow. While the US Federal government will spend $6.37 Trillion for FY 2023, state and local governments will spend $2.27 trillion. Note the delta in the late 1970s and early 1980s. To emphasize, The delta has never been greater in real dollars or as a percentage of GDP. Until spending is reigned in, inflation will continue.
The last key inflationary pressure is low unemployment. Current unemployment is about 3.5%. Inflation abates when we see unemployment of about 5%. Understand that most of the unemployed are only for a few months as they switch jobs. The labor market has some liquidity at the 5% unemployment rate. In the current tight labor market, employers must offer more money to hire employees, and candidates can demand more money. Where do we see this? Everywhere in almost every industry. It is currently a very tight labor market, with 1.6 jobs open for each unemployed person. On average, employees with degrees are now demanding a salary of $80,000 or greater to move to a new job, up from $72,500 last year. A tight labor market can also become a feedback loop. A wage-price spiral occurs when prices continue to get higher, and workers demand additional compensation to keep pace. That, in turn, can push inflation even higher as companies look to offset the steeper labor cost.
Think the Unions have not noticed this? You would be wrong. The tight labor market is behind the recent aggressive labor actions and union strikes. The Unions are striking when there is a shortage of labor – it is tactically good timing – but for long-term “strategy” – it will hurt them.
Now, what looks Recessionary?
In short, the consumers are running out of money and credit.
The savings accrued during the pandemic are already being depleted and will likely be exhausted at some point during the fall of 2023. Consumers are already shifting their spending habits, looking for better deals, and they are spending less. Consumer spending, which accounts for about two-thirds of the US’s economic output, grew 1.6% in the second quarter, down from a 4.2% rate from the first quarter.
Student debt: After a 3-year hiatus, 40 million people will start having to pay their student debt in October. With an average student loan payment of $500 – that is $20 billion less in consumer spending each and every month or $2.4 Trillion each year.
Manufactures’ new durable goods orders - no bueno! The durable goods orders are channeling their inner 2020s!
As of June 30, 2023, U.S. government bonds were 3.86 percent, while a two-year bond was 4.94%. This is an inverted yield curve. That is where bonds of longer maturities provide a lower yield. The inverted yield is a leading indicator of a recession. The yield curve inversion typically foreshadows a recession from 12 to 24 months in advance. The yield curve inverted in July of 2022. Further, the inverted yield curve spread has continued to widen, indicating the recession will be harder and deeper. This is the largest delta since the inflation and recession of the late 1970s and early 1980s.
According to the US Census Bureau, We are seeing fewer construction permits – we are 13% below this time last year, and construction spending has halved in the same time period. Speaking to construction professionals this last week, they are bidding more jobs and getting only a third of the jobs they got this time last year. Problems are financing and the combined cost of money, labor, and materials, which make many of the projects uneconomical.
So, the US has an inverted yield curve, durable goods are declining, GDP growth has stagnated, and we have to raise unemployment to address inflation as a nation.
Boom – Recession
It's just lovely - a recession with inflation.
L. Burke Files CACM DDP
Senior Researcher Unicus Research LLC and advisor to the founder
Weekender Music
Love and Marriage – Frank Sinatra A classic
Inflation Blues – BB King This is classic BB King – Wonderful
Dog Money – Remy This is brutal and fun.
Ah yes, the signs are all there: inverted curves, reduced consumer demand, outrageous federal spending, rogue waves of debt, inflation outflanked only by denial. No government (not even ours) can keep spending fake money forever. How far off are the layoffs and rising unemployment commensurate with crashing demand?
Soon we may be reacquainted with the misery index.
Another suggestion for your Weekender Listening for #34:
Phil Collins - In The Air Tonight https://www.youtube.com/watch?v=PEWP9nbqG9Q
- "So you can wipe off that grin, I know where you've been, It's all been a pack of lies!"
Mortgage application are at their lowest level since the 1990s' - no soft landing.
https://twitter.com/nickgerli1/status/1695173118560718889/photo/1