EDITOR'S NOTE: For many who weren’t around in the bad old days of inflation in the 1970s, the economic conditions heading into 2022 may seem new. However, Alhambra Investments writes that “inflationary overheating, tapering and terminating QE” are all things we’ve seen before, “and it didn’t end the way it was supposed to.” Jeffery P. Schneider, the Head of Global Research at Alhambra, writes about how we’ve seen this play out more recently, with Europe’s 2018 taper. The result was a lack of growth that hurt the European economy. Schneider wrote back then, “Quarterly real GDP growth moderated to 0.4% in the first quarter of 2018, following growth of 0.7% in the previous three quarters.” While there are plenty of differences between Europe in 2018 and the U.S. in 2022, Schneider says the chances of “Inflation Hysteria #2” and a “widespread Taper Rejection” are very possible, just like what happened in Europe in 2018.
The economy was in danger of running hot, too hot they all said. In order to stay ahead of such inflation potential, as central bankers saw it, first it would be necessary to wind down quantitative easing. Taper then terminate. After that, rate hikes.
Hawks buzzing around everywhere.
But Mario Draghi’s ECB had a problem. The inflationary pressures were there, he reasoned, just no one including Mario himself could find them in evidence. More worrisome than that, Europe’s economy also appeared to slowing down right then rather than speeding up or just maintaining the momentum from the prior year.
Whether or not Draghi really believed what he would say, or if Europe’s top central banker was just rationalizing for the public’s behalf, he crafted the story anyway as an excuse to bridge what was an ever-growing divide between his increasingly unreliable expectations and darkening reality.
Right in the middle of 2018’s European taper, with bond yields falling and curve flattening contradicting all of them, Mario told the media to tell the people to remain calm. All was still going to script, he claimed, and the obvious slowing in the economy was just it cooling off from 2017’s blistering pace.
Quarterly real GDP growth moderated to 0.4% in the first quarter of 2018, following growth of 0.7% in the previous three quarters. This easing reflects a pull-back from the very high levels of growth in 2017 and is related mainly to weaker impetus from previously very strong external trade, compounded by an increase in uncertainty and some temporary and supply-side factors at both the domestic and the global level.
It sounded logical, likely even. At the time, the idea of inflation and accelerating economic growth as in recovery was everywhere, foretold as if a foregone conclusion by everyone. If everyone says so…
Yet, all that was just hysterical noise, the illiterate bobbing of the crowd depending solely on the central bank view. As I wrote in response to Draghi’s panicked missive back in August 2018, the guy “spun his ass off.”
Playing to his home crowd, he knew the narrative about last year’s economic “boom” would go unquestioned. Therefore, if you think 2017 was some shade of awesome then a little slowdown in 2018 really wouldn’t be something to get worked up about. If, on the contrary, you see how last year was at best minimal, then cutting growth in half starting from lackluster is a different animal.
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What if the European economy hadn’t really boomed in 2017? The dangers therefore stark, as it might have meant the obvious slowdown (which only became more obvious with subsequent benchmark data revisions over the years) could turn out to be a bit more bothersome; as is exactly what happened.
In truth, the global “boom” during “globally synchronized growth” was the weakest reflationary period yet, leaving the entire system susceptible to its 2018 reversal. As a consequence, while central bankers tried their little best to hold up expectations, 2019 would be the year of forgotten recession (overshadowed by COVID) rather than the parades of recovery.
The clear 2018 slowing was a pivotal transition moment which left the public confused. Officials and their media all did (taper) and said (inflationary recovery) one thing while markets (not stocks) and data all did and spoke about rising, growing potential for only the other (full-blown deflationary downturn).
There are, obviously, stark differences between 2018 and 2021 beginning with the fact none of these cycles repeat exactly. However, even with the corona variable being something entirely new and pressing, there are very clear similarities in type.
Beginning with signs of slowing down, “growth scare”, which in many places is being rationalized the same as three and a half years ago: the economy was just on fire earlier in 2021, so coming off such a hot boil wouldn’t necessarily be that bad given recent CPIs.
So, we are left with the same general questions as before: what if early 2021’s “boom” along with its “inflation” were similarly a mirage like 2017? It may have looked red hot to some like Warren Buffett, yet in reality the money illusion of the supply shock and especially Uncle Sam’s singular interference may have only produced the appearance of a robust advance.
Whatever the case of the first part, like 2018 we’ve found ourselves looking into the second part – the slowdown – regardless.
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IHS Markit’s flash PMI readings for Europe and Germany, in particular, were hardly awful in most respects. The headline was 58.0 for Europe as a whole in December 2021, down a touch from 58.4 in November, and while that was the lowest since February it isn’t especially low.
But that number masked a growing unease, buoyed to the upside by others of its components than maybe the most important of them:
Overall inflows of new business decreased in December, thereby ending a sequence of growth stretching back to July last year. Weakness in demand was centred [sic] on the service sector, where the decline in intakes of new work gathered pace to the fastest since April. New orders received by manufacturers continued to rise, although the rate of growth was the weakest in the current 18-month sequence of expansion. [emphasis added]
Prices paid, prices received, supplier times, etc., these are all at or near record highs. New orders, on the other hand, have sunk to alarming lows.
It’s not just Europe or Germany as an isolated case, either. We’ve been talking about if not outright expecting a deceleration, to start, primarily via forward ordering being choked off by over-heated expectations. In the United States, the various regional manufacturing surveys (PMIs) produced by the disbursed branches of the Federal Reserve system exhibit this very tendency.
While it’s difficult to discern from what at first appears a tangled web of foggy contrition in regional new order estimates, there does emerge from that mist a very distinct pattern, one that looks all-too-familiar across geographies as well as time periods:
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According to these, the US manufacturing end of the global economy seems to have stalled since around May and the pace of new order flow for goods has decelerated to something like what was put up during the final few months of 2018.
This may not seem like a level or indicative pace to get all worked up about. But like the final months of 2018, it’s neither the level nor the current pace rather the clear trajectory and understanding the overall environment that trajectory is passing through as it really might be apart from how central bankers will end up wishing it would have been.
What if we’re slowing down – again – from what was never really close to an actual boom?
As to what it really could be that’s sapping purported strength into this slowdown, this one’s just as easy to finger as is the mainstream is forbidden to consider the possibility. I wrote back in September focusing in on new orders:
But it just might be inventory. Like several regional Fed manufacturing surveys lately, it’s still too early to draw hard conclusions but the possibility keeps rising by the month; by the datapoint no matter where it originates. If there is anything somewhat surprising, it’s not that this inventory issue may be working out in this way, rather how quickly it may have come about.
In the end, the global economy gets globally synchronized more often than not, just never in legit, inflationary growth.
Right in line with all that, the Census Bureau reported earlier on a monthly record (2.5%) wholesale inventory advance October 2021 from September, another big gain November from October (1.2%), and then yesterday an(other) outsized monthly gain in retailer inventory.
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According to their figures, inventories reported by retailers, excluding motor vehicles and parts, rose by 1.3% month-over-month last month. Contrary to popular perception and social media memes, when you look at the supply chain apart from car lots and oil tanks the economy is indeed awash in goods.
Right now, those goods are still selling at a relatively high pace. And yet, inventories have begun to outpace sales on the two trade levels of the supply chain. Inventories have gone vertical, too.
The risk is therefore the same type as 2018. A little drop off in demand for any reason has the potential to set up the self-reinforcing feedback loop which last time had turned globally synchronized growth into a globally synchronized downturn if not whole worldwide recession before the coronavirus ever let loose.
Such fragility lay in a “boom” which was never a legit boom at any time. The inflation expectations extracted from it therefore pure hysteria. A weak, slow upturn confused for a recovery doesn’t take much to go the other way and keep going wrong.
As Mario Draghi like Jay Powell would eventually have to concede by the middle of 2019. Each of the two major central banks after dismissing and rationalizing 2018’s clear change in character embarrassingly both had to turn around 180 degrees the following year.
Here, too, the implacable potential similarities.
One more common global factor to consider: China. Three years ago, the Chinese economy was said to be on its way up, a positive leader for the world to synchronize itself to when that was all just as much fantasy. Even the Communists over there were blatantly acting on a global economic impulse they saw and said was the entire opposite.
Yes, the Communists were far more honest. By every case, they still are.
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The only reason to consider all this another “growth scare” is that there is every reason, including recent history, to be “scared” of a global system without growth.
In a nutshell, Inflation Hysteria #2 and thus our low rates and flat curves worldwide, this widespread Taper Rejection. The world may be different in some respects nowadays, in these key economic, financial, and monetary realms there’s way too much exactly the same.
Originally posted on Alhambra Investments.