by Franklin J. Parker, CFA | for ongoing updates through the week, follow me on Twitter
The Summary
- This is a busy week for economic data. Tomorrow we get the Case-Shiller home price index for January with an expected average increase of 18.4% year-over-year. In addition, we get JOLTS job opening data for February (an expected 11 million job openings are expected) and consumer confidence (another drop is expected). Later in the week we see data on personal incomes, and on Friday we get the headline unemployment rate for February. All of this data will be watched closely as the economy has been showing signs of weakness lately.
- War in Ukraine continues to exacerbate inflation with grain, energy, and fertilizer prices spiking globally (more on that below). Last week, it appeared that a peace deal was in sight, but that seems to be slower in materializing. Russian authorities also seem to have indicated that their objectives in Ukraine have shifted—the main objectives now appear to be holding and expanding the “breakaway” territories in eastern Ukraine. In addition to the obvious humanitarian reasons, a peace deal sooner rather than later would help ease the global cost of this war.
The Details
Ok, I usually don’t do this, but I’m going on record with a couple of specific forecasts.
I now expect inflation will be in the low to mid teens in the Fall (I think 12% to 14% is on the table), and a recession appears ever-more likely in 2023.
There are several factors influencing my inflation call. First, the Russian war in Ukraine has increased both energy and food costs, both of which will not show up until next month’s inflation print. With both Russian and Ukrainian wheat markets cut off from global supply, this grain shortage is about to worsen yet another way. In retaliation for US-European sanctions, Russia has banned export of all fertilizer, sending prices soaring. With considerably higher fertilizer costs, many global farmers are likely to reduce the size of their planting this spring. Ultimately, some predict this will lead to considerable food shortages come the Fall (yielding considerably higher prices, of course).
Supply chains are likely to worsen between now and the end of the year. I have talked about some of the reasons for this before, and it appears that these factors have not been addressed over the past month since I looked at them.
Third, energy costs also show no signs of abating. Energy is an input to everything from manufacturing to transport to the electricity powering people’s homes. Higher energy costs pull dollars from the rest of the economy and force difficult decisions on lower-income households.
Finally, the Fed, despite its rhetoric, has few tools to fight inflation this time around. Exactly how they tame inflation is an open question as some of the problem is monetary and some is driven by other factors.
The recession question is one being thrown about more readily lately. As I have spoken about many times before, inflation can tip a fragile economy into recession, and, for the first time since 2019, there are some very early warnings signs of a recession, most notably in the US Treasury yield curve (see Chart of the Week). There are several other indicators on my recession dashboard flashing pre-recessionary signals. While I do not see a recession imminent, I do think the countdown has started. I see a recession posting sometime around late 2023 or early 2024 (based on today’s data).
Portfolio positioning is tough in this environment. Inflation is here to stay in my view, which means that cash is a poor option. My base-case is a rally in the back half of the year, albeit a rocky one. Moving into 2023, defensiveness appears the likely course, though that would be informed by data at the time. In the end, your goals will dictate what risks you can afford to take.
Chart of the Week
One of the more reliable indicators of coming recessions is the US Treasury yield curve. As the chart shows, the difference between longer-term yields and shorter-term yields compresses ahead of recessions, and some parts of the curve invert. The past months have seen that behavior begin, though it is not yet at the level to indicate a recession is imminent. At the moment, it would appear that we are entering the last year or so of the business cycle.
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