We just received headlines yesterday morning that a NY Fed survey was conducted on inflation expectations with the following headline releases:
*NY FED SAYS 1-YEAR INFLATION EXPECTATIONS FALL TO 5.7% VS 6.2%
*NY FED SAYS 3-YEAR INFLATION EXPECTATIONS FALL TO 2.8% VS 3.2%
Oddly enough this economic data was not even listed on any of the economic calendars to start the week. This means the Fed is probably trying to do some damage control for markets ahead of more Quantitative Tightening, and possibly ahead of this morning’s CPI release. Now I’m not going to bother to look deeper into this data, because this survey is probably just as rigged as the CPI to understate inflationary pressures in the economy.
However, I would assume whomever is taking surveys like this is not closely following economic data like we are. Likely, the catalyst for the lowering of inflation expectations in the survey are stemming from the recent drop in gas prices at the pump. Of course, the typical American does not know what the spot rate for a barrel of oil is, or that oil prices have been refusing to decline further since breaking below $90 per barrel. The average American also is probably not tracking on the tremendous imbalance between supply and demand in the energy sector.
Something else that the average American does not pay attention to is earnings calls from major US corporations. Numerous big name companies have mentioned in the past several weeks that there will be higher prices coming in the next few months. Cost pressures continue to burden businesses on the production side, but loose credit conditions continue to act as a tailwind for corporate earnings as businesses have been able to effectively pass price increases onto consumers.
Even if we look though at the numbers in the survey we see that even the lowered expectations remain at 5.7% inflation for the next year. That is not only almost 3x the target inflation rate of the Fed, but that implies people expect prices will be 5.7% higher next year on top of prices that have already risen by double digits in the past two years. Even if inflation does moderate a bit, if we remain at 5.7% next year and 2.8% over 3 years, that would be on top of the already drastic inflation that we’ve already experienced. In other words, the high prices we are dealing with now are in the best scenario here to stay forever. Under the expected scenario, things will worsen for middle-class consumers struggling to cope with inflation, and under the most likely scenario inflation is going to get much worse and weaken consumers much more from here.
But do inflation expectations even matter? Well, to an extent yes they do. The Fed would have investors believe that inflation expectations are the only cause of inflation, which is completely false. The notion being, if consumers expect higher prices in the future, they will not only buy more products now to hedge that future inflation (causing a drop in supply), but they will go to their employers and ask for raises. Of course, as people begin to expect more inflation, you can see that a self-perpetuating spiral can cause prices to increase in a snowball effect throughout the economy. But inflation does not start there. Inflation is an expansion of the money supply and credit. That expansion of money supply and credit artificially stimulates demand in the short run, causing the velocity of money (how quickly a dollar turns over in transactions in the marketplace) to pickup and cause prices to rise gradually. As long as credit continues to expand, demand will continue to expand as well. That means that businesses can raise prices without losing out on sales volume which will continue to cause more prices to rise for the foreseeable future. Of course, if the economy has already weakened to a point that it is in an official recession from the inflation we’ve already experienced, more inflation on top of the inflation we already have will put an even heavier burden on the economy.
This brings me to a Bloomberg article I read this morning:
The opinion piece, written by Bloomberg contributor Jonathan Levin is probably one of the dumbest pieces of financial writing I have seen all year.
Here are the three big pieces of data used in the article:
Revolving credit refers to open lines of credit that can be paid down, then re-opened again. Credit cards are revolving credit, because if you have a credit card with a $5,000 line of credit, you can spend $1,000 and then pay off the debt, thus giving yourself another $5,000 in potential credit.
Of course, all debts are revolving in a sense, because nothing happens in a vacuum. If I take a loan from one lender, revolving or not I can always take a loan from a different source to extend my credit. Think of it this way - If I take out an auto loan for $10,000 and the monthly service payment is $500 but I do not have any disposable income left after all my other bills to make the monthly payment, but instead choose to charge $500 of my grocery bill on a credit card so that I have cash left in my budget to service the car payment, I just turned my auto loan into a form of revolving credit, since I am ‘borrowing from Peter to pay Paul.’ In today’s low-interest rate economy, there is almost no limit to how much debt consumers can take on with a numerous amount of different lenders and loan types.
FICO scores and credit scores are not tools used by financial institutions to measure the financial responsibility of a consumer. They are tools used by lenders to determine how much money they can make on a given borrower. Sure, part of making money in the lending business is making sure your customers have the ability to pay back the loans. However, in many cases high interest rate products like credit cards don’t need 100% of their customers to pay loans back in full. Really, the big money is made from clients who continuously rack up debt and have the cashflow to service the debt interest payments each month, even if they never fully pay down the balance. In that sense, revolving products like credit cards are extremely profitable.
Another part of the credit card business that generates huge cashflows that most people don’t realize is data. Have you ever wondered how economic statistics are compiled? There is a huge market for economists, business analysts, and marketing professionals to understand the ‘what, where, why, and how’ of consumer spending. Credit card companies compile that data and sell it for huge sums of cash. So the value of a credit card customer is not just the interest they pay on their debt. That is why a lot of credit card lenders offer high cash rewards bonuses for opening a new credit card. Even if they lose some money in reward bonuses for new members, they make much more money on the back-end selling their spending data.
Now, what the article fails to recognize is that the only reason households are in better shape to service debt now is because of the government handouts that occurred during the pandemic. In fact, a lot of data is showing that this bump in savings is quickly running dry for most middle class households, and as stock market and home appreciation wealth begins to decline, the average household balance sheet will decline also. Not only that, but interest rates are still at historic lows. A lot of the revolving credit that is shown above is adjustable rate debt. If interest rates start to rise substantially from here, the cost of servicing existing debt will make it much more difficult for the Americans who are piling up the loans. We also have to recognize that the unemployment rate is still historically low, floating at 3.7%. Any increased pressures on the economy that weaken the labor market will hurt Americans who have become levered to the hilt with credit card, auto, personal, and student loan debts. Speaking of which, many Americans with student loan debt are still on extended moratoriums for paying those student loan debts off. Its easier to service existing debt if a big chunk of your household debt is in student loans and you have not had to make any monthly payments on that debt since the start of the pandemic.
Nonetheless it is not ok if the debt keeps building up, regardless of whether or not it is serviceable for most people. Because money and credit are not endless, they are scarce resources (The fact that money and credit have not been scarce for two decades is why we have an enormous inflation problem now). Recognize that if someone is going to borrow money, somebody else somewhere had to save money first in order for a financial institution to be able to lend it out. Sure, lenders can make out an exponential amount of loans relative to capital reserves, but the more you increase outstanding loans vs. capital reserves the more risky the entire system becomes. Part of the reason for why the 2008 Financial Crisis occurred was because way to many loans were outstanding in the economy that consumers and homeowners could no longer afford to service. The economy in terms of outstanding loans is far more leveraged now, and those dominoes have to fall eventually. That is why the article is so ridiculous. It is not ok for consumers to continue to pile on endless amounts of debt, revolving or non-revolving. If they do, not only does the credit bubble get even bigger, but inflation gets even worse as endless sums of credit create endless sums of demand chasing a stagnant supply of goods & services.
Lastly, if savings continue to dwindle away the only way in which more credit can be extended other than levering up the economy even more is to have more money printed. The savings rate in the US economy is currently at its lowest levels since 2007. If nobody is saving money anymore, what pool of savings are people tapping into for more credit? Well, for now borrowers are tapping into a shrinking supply of savings, so if the credit bubble continues to expand, it will either have to expand by financial institutions getting more levered up, or by the Federal Reserve continuing to expand the money supply or the supply of credit through continuously low interest rate policies, all of which would be inflationary. Clearly, none of the participants in the NY Fed survey of inflation expectations have any understanding of this whatsoever.
CPI is released in just over an hour. Consensus amongst economists is a -0.1% print. It does seem to be the general consensus amongst investors that we will come in more negative than expectations, since seemingly most of the market is buying the peak inflation narrative. My guess is that we come in around 0.3%, by I am just grasping at straws here. Since the CPI is completely rigged and calculated differently every month with nonsensical adjustments, there really is no accurate way of telling what is to come of this inflation metric each month. I would suspect that it is quite possible to see a negative print, since after all we have not had any inflation damage control in advance from the Biden administration. If you recall, the last time the CPI came out really high 2 months back, Biden gave a speech on inflation the night prior. Perhaps the quietness from the White House means this month’s number isn’t too bad. Either way, if the CPI is much more negative than 0.1% the markets should rally, anything above 0% and the markets should sell off sharply. It is also important now to start looking at the year-over-year numbers. The current year-over-year inflation percentage is 8.5%. If we don’t start to see that number come down meaningfully in the next few months, more pressure will mount on the Fed to get moving more quickly in its inflation fight.
Best
Ryan Garzone
True North Market Research, LLC
truenorthinternationalpartners@gmail.com