Morning Report: Parsing the Beige Book

Vital Statistics:

S&P futures4,519-9.2
Oil (WTI)83.11-0.39
10 year government bond yield 1.67%
30 year fixed rate mortgage 3.27%

Stocks are lower this morning on no real news. Bonds and MBS are down again.

Initial Jobless Claims fell to 290k last week, which was lower than expected. We are still well above pre-COVID levels however.

The economy grew at a “modest to moderate” rate in September, according to the Federal Reserve Beige Book, which is a report by all of the regional Fed banks on the economy. The overall punch line is that growth is slowing and supply chain issues and a lack of labor are pushing up prices.

On the overall economy, they said: “Economic activity grew at a modest to moderate rate, according to the majority of Federal Reserve Districts. Several Districts noted, however, that the pace of growth slowed this period, constrained by supply chain disruptions, labor shortages, and uncertainty around the Delta variant of COVID-19.”

On the labor market, they observed: “Employment increased at a modest to moderate rate in recent weeks, as demand for workers was high, but labor growth was dampened by a low supply of workers….Firms reported high turnover, as workers left for other jobs or retired….The majority of Districts reported robust wage growth. Firms reported increasing starting wages to attract talent and increasing wages for existing workers to retain them. Many also offered signing and retention bonuses, flexible work schedules, or increased vacation time to incentivize workers to remain in their positions.”

And on inflation: “Most Districts reported significantly elevated prices, fueled by rising demand for goods and raw materials. Reports of input cost increases were widespread across industry sectors, driven by product scarcity resulting from supply chain bottlenecks. Price pressures also arose from increased transportation and labor constraints as well as commodity shortages. Prices of steel, electronic components, and freight costs rose markedly this period. Many firms raised selling prices indicating a greater ability to pass along cost increases to customers amid strong demand. Expectations for future price growth varied with some expecting price to remain high or increase further while others expected prices to moderate over the next 12 months.”

What does all of this mean? For the Fed, the issue of inflationary expectations is critical. Once the population expects higher prices in the future, it tends to create a self-reinforcing cycle. Consumers accelerate purchases in order to avoid paying more in the future. This exacerbates supply shortages. Workers demand bigger cost-of-living wage increases which bumps up labor costs. Economists call this the wage-price spiral and this was a big component to the 1970s inflationary period.

There are many similarities between the 1970s and today: commodity price increases, shortages, profligate government spending and extremely easy monetary policy. As long as the economy is strong, people grudgingly accept it. The problems begin when the economy slows, because fiscal / monetary policy have reached the point of diminishing returns. Economists call this “pushing on a string” which means that further stimulus doesn’t create growth – it just creates inflation.

Jimmy Carter referred to it as “malaise.” Economists called it stagflation. Regardless of what you call it, I suspect it will be the template going forward. The government spent a crap-ton of money stimulating the economy over the past year and a half, the Fed has cut interest rates to 0% and has been buying MBS and Treasuries to support the economy. In return, economic growth is “modest to moderate,” which is Fed-speak for “meh.”

The Fed and the government have been conducting a stealth experiment in modern monetary theory over the past year and a half. Investors should ignore any gaslighting out of the media that offers MMT as a potential solution, as if we aren’t already there. We are. And we should get the verdict on that experiment soon.


Author: Brent Nyitray

In the physical sciences, knowledge is cumulative. In the financial markets, it is cyclical

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