Which one will you believe, the current Federal Reserve or the Secretary of the Treasury who also happens to be the previous Fed chair? The answer can’t be “neither,” unfortunately, as there either is or isn’t going to be a recession later this year.
As for Treasury Secretary Janet Yellen, she was among the most accommodative Fed chairs in recent memory. It’s hard to imagine that she would ever have tightened the screws on the economy like Jerome Powell, the current Federal Reserve chair, is doing in 2023.
But then, Yellen never had to face sky-high inflation when she was in charge of the nation’s central bank. Now, as Treasury Secretary, Yellen gets to comment from the sidelines without actually having to take the risk of raising interest rates and implementing quantitative tightening.
Hence, it’s easy for Yellen to get on her soapbox and be a dyed-in-the-wool recession denier. As you may recall, back in February Yellen denied the existence of a recession in the U.S. because unemployment was low. She’s doubling down on that position now, saying she’s “not anticipating a downturn in the economy” as “the U.S. economy is obviously performing exceptionally well.”
Of course, this isn’t “obvious” to the American middle class when housing is unaffordable, car payments take up a third of people’s paychecks, and inflation is still much higher than the Fed’s 2% target. Meanwhile, the most recent FOMC meeting minutes specifically project that a recession will happen later this year.
The actual quote from the meeting minutes is that the Fed’s “projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years.” Can you remember a time when the Federal Reserve actually predicted an imminent recession?
Courtesy: St. Louis Fed
It’s not difficult to find recession indicators to back up the Federal Reserve’s projection. One of the most reliable indicators is the M2 money supply, shown in the chart above. With the U.S. money supply falling at its fastest rate since the 1930s, it’s going to require a miracle to avert an economic downturn.
If money is the lifeblood of the economy, then quantitative tightening has drained the blood out of the system and that’s bound to have a negative impact. However, the stock market is still in denial as there’s a lag effect, so the other shoe won’t drop immediately.
Consequently, it’s entirely possible for the S&P 500 and other major stock market indexes to melt up in the short term. Remember, the stock market is a voting machine in the immediate term, but is a weighing machine in the long run.
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And so, you’ll see voting-machine behavior in the short term. A current example would be Shark Tank celebrity billionaire Barbara Corcoran telling young people to “forget about the timing” and to “to beg, borrow, and steal” to get into the real estate market “as fast as you can.”
Of course, it’s easy to say that when you’re a billionaire. Here in the real world, home prices across the U.S. rose 74% from 2010 to 2022; meanwhile, the average wage only increased 54% during that time. But hey, just “forget about the timing” and “borrow” like it’s early 2008, right?
Along with the shrinking supply of money in the economy, investors should observe tightening credit conditions – i.e., banks are hesitant to loan money to businesses and individuals. America, for better or for worse, runs on credit, and it’s going to be difficult for the economy to run smoothly if lending activity is stifled.
Then there are corporate earnings to worry about. The 2023 consensus EPS for S&P 500 companies is cliff-diving, down 13% since June 2022. There are a number of culprits at work here: sticky inflation, high interest rates, the aforementioned strict lending conditions, etc.
I could also point to multiple deeply inverted yield curves, the drop in the Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index (PMI) in March, and so on. In response, you can either weigh the evidence and form your own conclusion, or you can simply believe Yellen when she says the economy “is obviously performing exceptionally well.”
It pains me to say it, but I’m siding with the Fed on this one. The central bankers slipped up and let the truth out for a moment, and while many retail traders didn’t catch it, the cat’s out of the bag and there’s no turning back now.
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