May 20, 2022

Traveling this week, so just an abbreviated note.

Despite high inflation and higher interest rates the economy continues to chug along.  That is both good news and bad news.  The good news is that the economy seems to be performing well.  The bad news is that it is  performing so well that it is going to take much higher interest rates to slow it down.  Our view is that real interest rates are likely to remain negative for the foreseeable future.  The economy is not going to slow appreciably until those real interest rates become positive.  If we are right that the core CPI increases 6.4% this year and 5.8% next year, and the Fed raises the funds rate only to 3.5% by the end of 2023, then real rates are going to remain negative for the foreseeable future.  The economy will continue to expand at a moderate rate.  But that also means that inflation will not slow in any meaningful way.  At some point the Fed will have to be willing to push interest rates above the inflation rate to have any chance of reducing inflation.  So no recession for now, but no significant improvement in inflation either.  Unfortunately, the Fed has planted the seeds of the next recession by waiting so long to start reversing its extremely easy monetary policy stance.  Once it gets serious about combating inflation, and real rates turn positive (which could imply an eventual 6.0%+ funds rate), then we should start worrying about recession.  It is coming but not yet.

Stephen Slifer


Charleston, S.C.