Thankfully, inflation readings are coming down, and investors are betting that the Federal Reserve is nearing the end of its rate-hike cycle.
But according to Jim Caron of Morgan Stanley Investment Management, who says he is fretting over that prospect, any potential re-spiral in prices could complicate things substantially.
“The risk that keeps me awake at night is that we get this decline in inflation in the first half of the year, which we know is happening, but suddenly we find out in the second half of the year that it is stable. No – it bottoms out, but then all of a sudden starts showing signs that it could start to bubble up in 2024 and beyond,” he said on the “What Goes Up” podcast.
Karen, co-chief investment officer of Global Balanced Funds at Asset Manager, stirred markets ahead of Friday’s red-hot payroll report. Here are some highlights of the conversation, condensed and lightly edited for clarity. Click here to listen to the full podcast on Terminal, or subscribe below on Apple Podcasts, Spotify, or wherever you listen.
Q: There is always the question after the FOMC press conference, did Powell not get the message he intended? And should we expect some aftershocks in the coming weeks?
A: I think one of the risks that I think we’re going to be coming across over the next few weeks is that if the intended market response doesn’t match, as is typical, something is going to happen. running backwards.
What Powell said in the statement was seen as relatively offensive. And then all of a sudden he starts his press conference, and he basically says the exact same thing that he said in December. It was almost a carbon copy of those issues – that labor markets are tight, which is raising inflation risks. Second, despite the decline in CPI and wage inflation, it is still too high for inflation to stabilize at the target level.
And then he starts talking about service-sector inflation versus goods-sector inflation. And he said, look, we know why inflation is coming down – durable goods, supply chain, all those things are definitely coming down – but service sector inflation is not coming down as fast as they would like Are. And then he said that service-sector inflation, if we look at it, he said that core services haven’t even begun to fall out of housing. So this is a man who is worried about inflation. This is someone who hasn’t bullied by any stretch of the imagination.
Then he went on to say, wouldn’t it be a shame if inflation is a problem on the verge of being resolved, that we didn’t act tough enough, and then all of a sudden later it starts up again? That would be really bad. And for me, that is my main risk.
Apart from all the geopolitical potential risks, the risk that keeps me up at night is that we get to see this decline in inflation in the first half of the year, which we know is happening, but suddenly we get this. Realized in the second half of the year. The year it doesn’t stabilize—it comes down, but then suddenly starts showing signs that it could start to bubble up in 2024 and beyond. And then they have to come back inside and start hiking again from an already higher base.
This is not the price in the markets. Everyone is talking about pivoting and expecting rates to come down – it would be a significant surprise and really bad for asset prices if in fact it all turned upside down and all of a sudden,’ the Fed said. No, we really have to start our hiking cycle again.’ So it doesn’t sound like a guy who is ending his inflation-fighting plight.
Q: So if this is a risk that’s keeping you up at night, how do you classify it?
A: So it is a one tail risk, but it is a fat tail, meaning it has a higher-than-normal probability for the event to occur. And I would subjectively keep it at 20% as well. So what does that make? Certainly energy prices can do that. We know that there is not enough production relative to the demand.
But for me, this is not the main issue here. The main issue is the labor market. The labor market is surprising everyone. Most models haven’t really worked in terms of trying to predict labor. Look, we got a JOLTS survey that came out and showed essentially 11 million job opportunities. The second is the vacancy-to-unemployment rate – two jobs open for every unemployed person.
So while consumer confidence is coming down because we’re hearing about layoffs in the tech sector and these huge numbers that are being thrown out there, the reality is that when we look at unemployment claims, when we look at the unemployment rate When we look at the BLS surveys and statistics, what we’re finding is that these people who are being laid off in the tech sector are finding jobs in other sectors. Now, the nuance here is that the jobs they are getting are low paying.
Now I want to be very clear about this because I think this is a turning point for 2023 — 2023 is going to feel worse for Main Street and better for Wall Street. 2022 looks bad for Wall Street and better for Main Street.
If we look at 2022, we see inflation going up to 40-year high. But what we had was job creation. People were employed, the jobs market was still very, very strong and hadn’t started to weaken. So even though higher prices were coming into the economy, people realizing they have jobs, they can afford higher prices, they still go out to eat at restaurants and spend time in hotels and on airplanes They go and do all these different things.
We are now nearing the end of this inflationary cycle—at least for now. It’s starting to come down. We’re coming to the end of this rate-hiking cycle, equities are responding positively, bonds are responding positively — if you ask the people on Wall Street, ‘Hey, look, things are great.’ If you ask people on Main Street, they’re talking about the exact opposite.
Click here to listen to the rest of the episode.
-With assistance from Stacy Wong.
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