Inflation readings, mercifully, have fallen, and investors are betting the Federal Reserve is nearing the end of its rate hike cycle.
But any potential re-spiral higher in prices could complicate things significantly down the line, according to Morgan Stanley Investment Management’s Jim Caron, who said he was fretting over that possibility.
“The risk that keeps me up at night is that we have a drop in inflation in the first half of the year, which we know is happening, but suddenly we know that in the second half of the year there is no anchor – it’s going down, but then suddenly it starts to show signs that could start the bubble up in 2024 and beyond,” he said on the “What Goes Up” podcast.
Caron, co-chief investment officer of Global Balanced Funds in the asset manager, said before there was a report red-hot payrolls rattled the market. Here are some highlights from the conversation, which have been condensed and lightly edited for clarity. Click here to listen to the full podcast in Terminal, or subscribe below on Apple Podcasts, Spotify or wherever you listen.
Q: The question after the FOMC press conference is always, did Powell not get the message he wanted? And should we expect some whiplash in the coming weeks?
A: One of the risks that I think we’re going to face over the next few weeks is that the intended market reaction doesn’t match what the statement says, so as always, there will be some. walk backwards this.
What Powell said in his statement was considered relatively hawkish. Then suddenly he started a press conference, and he said exactly what he said in December. It is almost a carbon copy of the problem – that the labor market remains tight, which keeps the risk of inflation elevated. Second, despite the decline in CPI and wage inflation, it is still too high to be consistent with inflation being an anchor at the target level.
Then he started talking about service sector inflation and goods sector inflation. And he said, look, we understand why inflation is coming down – durable goods, supply chain, all of these things are definitely coming down – but service sector inflation is not coming down as fast as we’d like. And then he said that the inflation of the service sector, if we look at it, core services ex-home said it has not even begun to fall. So here are the people who are worried about inflation. This person is not completely tightening by any stretch of the imagination.
Then he continued to say, isn’t it a shame that just when there is inflation on the verge of becoming a problem that is solved, we are not tight enough, and then suddenly it starts to rise again. at? That would be too bad. And for me, that’s the main risk.
Apart from all the potential geopolitical risks, the risk that keeps me up at night is that we have a drop in inflation in the first half of the year, which we know is happening, but suddenly we know in the second half. the year that is not anchored – came down, but suddenly it began to show signs that could start a bubble up in 2024 and beyond. Then he had to return and start hiking again from the already high base.
The market does not have this price. Everyone is talking about the pivot and the hope that rates will come down – it will be a significant and very bad surprise for asset prices if in fact this is all turned around and all of a sudden the Fed says, ‘No, we have to restart our hiking cycle.’ So this is not like someone ending the situation against inflation.
Q: So if there’s a risk that keeps you up at night, how would you categorize it?
A: So it’s a tail risk, but a fat tail, which means there’s a higher than normal chance of that happening. And I even subjectively put the highest as 20%. So what makes it? Of course energy prices can be done. We know that production is not enough to meet demand.
But for me, that’s not the main issue here. The main problem is the labor market. The labor market is confusing everyone. Most models really don’t work well for predicting labor. Look, we got the JOLTS survey that came out and it basically showed 11 million job openings. The other is the vacancy-to-unemployment rate – there are two jobs open for every unemployed person.
So while consumer confidence is down because we’re hearing about layoffs in the tech sector and the big numbers being dumped there, the reality is when we look at jobless claims, when we look at the unemployment rate, when we look at BLS surveys and statistics, what we find is that people- people who are laid off in the technology sector find work in other areas. Now, the nuance here is that the jobs you find are cheaper.
Now I want to be very clear on this because I think this is an important point to make for 2023 – 2023 is going to be worse for Main Street and better for Wall Street. 2022 feels worse for Wall Street and better for Main Street.
If we look at 2022, what we see is inflation reaching a 40-year high. But what we also have is job creation. People are working, the job market is still very strong and has not started to weaken. So even though prices are higher in the economy, what people know is that if they have jobs, they can pay higher prices, they’ll still eat in restaurants and spend time in hotels and get on airplanes and do all these things. variety.
Now we will end this cycle of inflation – at least for now. It started to go down. We’re coming to the end of this rate-hiking cycle, equities are responding positively, bonds are responding positively – if you ask people on Wall Street, ‘Hey, look, that’s pretty good.’ If you ask people on Main Street, they say the opposite.
Click here to hear the rest of the episode.
-With help from Stacey Wong.
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