Pro Perspectives 6/13/23

June 13, 2023

The headline inflation number came in this morning right at 4% year-over-year.  And as we've discussed, even if June were to be a hot number, the rate-of-change in next month's report (relative to June of 2022) will fall to the mid-3s.  
This is why the Fed has been telegraphing a "skip" on the rate hiking cycle tomorrow.  
Not only is the headline number falling sharply, but the Fed, at an effective Fed Funds rate of 5.08% is above its favored inflation gauge, core PCE, which is running 4.7% at the last reading.  And taking the Fed Funds rate above the rate of inflation has historically been the antidote for putting downward pressure on inflation.
So, a "skip" by the Fed is fuel for stocks
As we discussed yesterday, the Nasdaq and S&P 500 have well broken out of the bear market downtrend of last year.
The Dow and Russell (small caps) are just breaking out. 
Here's an updated chart on the Russell, which was one of the best performing stock indices in the world today.  
That said, this "skip" from the Fed doesn't look like a "stop," much less and "stop and reverse." 
The core inflation rate (ex food and energy) remains above 5%. 
And, importantly, the sharp fall in the headline rate has been brought to us by manipulation, namely the Biden's administration's liberal use of the Strategic Petroleum Reserves — draining 40% of the reserves to put downward pressure on oil prices.
It's now time to restock
And through anti-oil policies, we've ceded control over production to OPEC+.  It seems likely that higher oil prices are in our future.  
That will underpin inflation.
Meanwhile, the Treasury will be issuing over a trillion-dollars in new debt over the coming months (on top of the existing unsustainable debt burden).   
All of this, and as we look around Japanese stocks are making new 33-year highs (nearing the old record highs).  German stocks are near record highs.  And U.S. stocks are resuming flight. 
And we have the early stages of a fourth industrial revolution underway (driven by generative AI).
Complicated paradox?  Or is this the formula we've been discussing in my daily notes taking shape?
For details, let's revisit my February 27th note …
We need a period of controlled hot inflation, as long as it comes with hot nominal economic growth.
The government debt has doubled, relative to the size of the economy since the Great Financial Crisis.
As you can see, this is Great Depression/World War II level debt.
The only solution:  It has to be inflated away.  That has to come through hot nominal growth.
With that in mind, a boom-time period in GROWTH is way overdue.
Remember, we've looked at this next chart many times throughout the history of my daily Pro Perspectives notes …
In my chart, the blue line is the path of real GDP IF it had continued to grow at the long-term average rate of 3.8% (that's the average growth rate from 1929).
So, if the economy had continued to grow "on trend" we would have a $26 trillion economy (the blue line).
Instead, we had the Great Recession.  And instead of having the big bounce back in growth, that is typical following recessions, we had dangerously shallow and slow growth for the better part of a decade.  And that growth was only due to the Fed propping the economy up through continued ultra-low rates and QE.
With that, the economy was knocked off (trend) path fifteen years ago, and the gap between trend and actual growth has only widened.  We have an economy $6 trillion smaller than it would be had we stayed on trend.
This gap (between trend and actual GDP), and the (already) ballooned debt-load, explains why the Treasury (under Mnuchin) and the Fed (under Powell) didn't hesitate to go big and bold to respond to the Covid shutdown.  It was an excuse to do what had to be done — inflate.
Of course, the politicos are opportunists, and they've taken advantage of crisis, pushing what was "big and bold" into "wild excess" (to fund their agenda).
With the damage from wildly excessive spending, the Fed's challenge has been to take the threat of hyper-inflation off the table, but leave the economy with stable, but hotter than average inflation.  They may have done the job, but they will have to continue maneuvering/manipulating along the way. 
Again, this note was from February.  Fast forward to today, and this formula of hot growth, hotter than average inflation and rising wages appears to be coming to fruition.  It would be good for stock prices.  And it would inflate away the value of debt.  
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