Inflation will be suppressed by recession – not the Fed

I woke this morning to enthusiastic honking from the media with respect to Tuesday’s encouragingly strong start to the trading year. I guess none of them will have read the closing lines of last morning’s column in which I wrote: “Much is made of market illiquidity towards the end of the year but it is often forgotten that the early weeks of the new year are also highly technical as banks are busily rebuilding trading inventories which had been run down into year-end while investment firms have yet to have their Q1 investment committee meetings and the flow of new money has not kicked in. Experience has taught me not to take early January market movements too seriously and certainly not to extrapolate the customary rally into annualisation.” ‘nough said?

In the first “big event” of 2023, we will at 14:00 EST get to see the minutes of the Federal Open Market Committee’s December meeting and there is no doubt that they will generate even higher levels of interest than usual. The Fed appears to be flip-flopping in its forecasts for inflation in 2023. In November it seemed sanguine. By December, if Chairman Powell’s post-meeting comments were to be believed, the committee was feeling a lot less secure in its forecast for inflation to begin to sustainably fall by mid-year. Arguments in both directions are easy to construct and to be frank, I don’t think the good folks at the Fed really have a clearer view than do the rest of us. But in the aftermath of the “transitory” fiasco and their very clear failure to begin tightening monetary policy soon enough, who could blame them for preparing for the worst while hoping for the best?

Much has been made of the ongoing lack of central bank credibility – it affects not only the Fed – so who could blame the powers that be for talking tough? All the while, there are rising voices throughout the Fed watchers’ community which suggest that it might be beginning to soften its stance. To me that would mean it tacitly shelving the 2% inflation target, something which I have been advocating rather than predicting for many, many months.

Yesterday morning I remotely attended the first meeting of the year of the investment committee on which I sit as an external advisor. This was a preliminary meeting at which the executives got the opportunity to quiz the externals on their opinions ahead of the actual quarterly meeting. Inevitably inflation was the central theme. My base case for the currently high inflation rate to begin to wane as the base effect of annualization begins to push the numbers lower, come February and the first anniversary of the Russian invasion of Ukraine. All the while, President Xi Jinping’s rush for growth will surely support the strong recovery in base metal prices. Today we hear that Beijing is playing with the thought of lifting the sanctions on Australian coal. If that doesn’t tell of what Beijing’s intentions are, what will? And there lie the foundations for a possible second wave.

But then there is one more towering unknown and that will in all likelihood be highlighted in the FOMC’s minutes. It casts a long shadow and is the risk of an incipit wage/price spiral. The state of the post-Covid US labour market presents the Fed with a headache for which there are no pills. The shortage of labour – the low unemployment rate is to a large extent a function of the worryingly low participation rate – when added to the rising cost of living cannot but exert upward pressure on wages. There comes a point, however, when attempts to curtail demand by raising the cost of borrowing result in rising wage demands as workers o=look to protect their standard of living. The Fed will be cognisant of the risk of it digging its own grave if it pushes too hard on the interest rate button.

Conventional thinking is that if it overtightens, it will push the economy into recession. That might be true although I believe that the risk from over-tightening is far greater if it removes the cork and releases the dreaded wage/price spiral which is then desperately hard to put back in the bottle. The Bank of England, along with Rishi Sunak’s Conservative government, is faced with just that conundrum with large swathes of the UK’s public sector either threatening to strike or already on strike. The wage/price rabbit hole is one which no administration would ever want to go down. The Tory government in Westminster is tired and divided and the unions know that they have a unique opportunity to kick it whilst it is down. As unpopular as they might be for striking, they can sleep soundly in the knowledge that they will remain for a while less unpopular than the government. That said, the leaders of trades unions on strike have an uncanny ability to overplay their hand by forgetting the pain they are inflicting on the millions of voters and taxpayers who stand between them and their sworn enemy in Westminster. I digress.

I feel comfortable with the view that the Fed will tighten twice this year by 0.25pts a time and that it will then step back and let the storm blow itself out. I do not, at this point in time and given the information available, believe that it will push Fed Funds above 5%. As I wrote in one of my last pieces before Christmas, I reckon Mr Inflation will not be suppressed by the Fed but by Mr Recession. Position unch’d.

Tesla nosedives

Elsewhere, I yesterday commented on the, in my view, ridiculously high p/e ratio of Tesla versus other car makers. This prompted the response by one reader as follows:

“I have a few techie youngsters I have invested with over the years. One is a Fulbright, MIT and 10 year Google ninja and they all explain to me that the reason Tesla has such a high multiple versus other car producers is because it is not a car company. It makes cars, yes, and very good ones but it is a data collection company/AI.

AI companies, which do have multiples of 30x plus are the new game in town and they all need data to work. ChatGPT is a case in point.

Tesla has recorded every mile driven by every Tesla car since inception. The data it holds is the foundation required for self-drive cars. Analog car companies have not been doing this
Musk assures us that once automated driving is 10,000 times safer than human beings people will use them and the AI car is born. At that point, and, I’m told, we are getting very close, Tesla will become a fully recognised AI company that uses cars to monetise its data.

In analogue terms. McDonalds is not a restaurant chain it is a real estate company. Amazon is morphing into a web services and customer database collection service. Google is about to be seriously challenged by ChatGPT… it is the marriage of big data with AI that determines multiple valuation these days.

Twitter is the mother lode. 3 million data actions a second. Musk is all about the data and anyone under the age of 32 would agree.”

I responded:

“I’m afraid we shall have to agree to differ. Tesla is in my mind and I can assure you in the eyes of many auto industry professionals a second class car maker dressed up a tech wizard.”

A few hours later, the following arrived in my inbox:

“Slightly bad timing on my part. It’s down 12% today!!! “

Tesla stock closed yesterday at US$108.10, down US$15.08 or 12.24% on the day. In the aftermarket it lost a further US$1.03 or 0.95%. As might have been expected, Cathy Wood was out there buying. That her having acquired 176,000 shares for less than US$ 200,000 in a company that still sports a market cap of US$341bn still makes front page news should tell us something which is that she is either very smart or the financial press very dumb. I know which way my vote goes. Ms Wood’s Ark fund lost 63% last year. Her other large bet, Coinbase, lost 5.06% yesterday and the ARK Innovation ETF shed 2.5%. Ms Wood can thank the heavens there is no law against stupidity.

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