Opinions
According to Wikipedia, the origins of the frog and scorpion parable may be traced back to the first half of the 19th century. Despite this, with more than 150 years of experience, investors in the capital market had 14 years of monetary celebration to err on the side of the Fed’s character and basic role. Since 2008 the prevailing perception in the markets is that the role of central banks in general and of the American one in particular is to support the financial markets and help them whenever investors lose some momentum. However, a look at the not-so-distant history of before 2008 will teach us that by virtue of his role, the Fed is not a friend of investors but the responsible and annoying adult who comes to ruin the party just when it starts to get interesting.
Accordingly, as Powell stressed in his speech last week, the Fed’s current goal is to halt inflation and inflation expectations at any cost, even if it means it will have to make some sharp and rapid interest rate hikes and start narrowing the balance in the coming months. In other words, the volatile environment is here to stay since henceforth the liquidity of central banks is not expected to give support to the markets as it has given in previous years. Last week they argued that the Fed has no exercise price on the put option as long as inflation is at current levels and after Powell’s speech it seems that this estimate has only strengthened. Even entering a bear market will not change the Fed’s direction as Powell could not justify a more tolerant policy towards inflation just to help investors.
In addition, it is also worth remembering that the public and political pressure on the Fed today is enormous since from the administration’s the breach of trust on the part of the consumer who has to see his spending grow at an almost double-digit rate only due to rising prices, more severe than the damage to Wall Street. Accordingly, bottom line, until inflation does not subside significantly the Fed will continue to reduce its policy as sharply as possible.
Growth figures show the slowdown in the doorstep
Growth figures for the fourth quarter of 2021 in the US were released last Thursday and surprised upwards considerably. However, the immediate conclusion drawn from the data is that the best is probably behind us and that growth during 2022 is expected to be much slower. This conclusion stems from each of the three main items of GDP: private consumption, investment, and government consumption (the contribution of foreign trade items in U.S. GDP to growth is insignificant) so it is difficult to see a different scenario.
- First, growth in the fourth quarter of the year was 6.9% (compared to expectations of 5.5%), but most of the growth came from the inventory component, which contributed 4.9% of the total growth, and not demand components such as consumption, investment or exports. In fact, if you look at sales to the domestic market (growth without the effect of inventories and without the effect of foreign trade) then you see that the growth in the fourth quarter was only 1.9%. Not only that, but the increase in inventories in the fourth quarter naturally reduces the growth potential for 2022, especially in light of the slowdown that can already be seen in the first quarter (the Fed’s GDPNOW model forecast is now only 0.1%).
- Second, the consumption item, which is of course the most significant item in the US product, clearly shows the slowdown that already began in the fourth quarter when the increase in product consumption was only 0.5% and that of services consumption slowed from 8.2% in the third quarter to 4.7% in the last quarter of the year. Looking at 2022, it can be assumed that in the first quarter of the year there will be a significant slowdown in service consumption due to the effects of the corona wave but more importantly, the potential for growth in product consumption is very low. On the one hand, high inflation has eroded the real income of the American consumer and on the other hand that consumer is in a state of “saturation” in terms of consumption of durable goods after a year and a half of shopping celebration.
- Third, U.S. fiscal policy will also contribute to a slowdown when, beyond the fact that most of the administration’s plans to support the economy have ended, it seems that the chances of Biden’s plan to get off the ground are diminishing day by day. The optimists in the forecasters also estimate that Biden will eventually succeed in passing a plan in the Senate that is about half of what he planned (that is, about $ 1.5 trillion), while quite a few estimate that in the end the plan will be significantly smaller as well. Therefore, if in the last two years the administration’s contribution to growth has been significant, then in 2022 it is possible that the administration’s contribution will be negative at all.
- Fourth, the investment item contributed only a quarter of a percent growth in the fourth quarter of 2021. If that is not enough then the trends in the various components of investment in the economy indicate a change of direction in the economic cycle. Historically, investment in commercial real estate has tended to lag behind the economic cycle and has risen by 11.4% but this is probably past news. Investment in equipment and machinery, which usually tends to move in parallel with the economic cycle, increased by only 0.8%. In contrast, investment in residential real estate, which tends to precede the economic cycle, decreased by 0.8% in the fourth quarter. In other words, the investment section teaches us that the peak of growth in the US is behind us.
- Bottom line, GDP data paints the same picture we have been emphasizing for a long time, the Fed starts raising interest rates at the end of the economic cycle so even if interest rate hikes are sharp in the short run, they are limited in the medium term by slowing the economy to support inflation.