There are two countervailing forces that will determine the course of interest rates and the economy over the next couple years, and getting the interplay right will probably mean the difference between a stagflationary hellscape and an economy growing without the need for stimulus (deficits) amounting to a truly demented 7% of GDP.
Without anything being done on deficits the debt and the interest on the debt will continue to grow until the yield demanded by Treasury buyers becomes impossible to pay and the Federal Reserve is forced to step into the market and print money to buy enough newly issued debt to allow the Treasury meet the interest payments.
This is the definition of a Ponzi scheme and is the point from which there is no turning back.
Add in the inflationary effects of what are loosely being referred to as tariffs, anywhere from 0.4% to 1.5% on the CPI depending on substitution effects and behavioral changes.
Opposing the deadweight and inflationary forces is any success that might come from deficit reduction in the immediate and near-term.
Two weeks ago I would have given the administration a less than 5% chance of cutting $750 billion or more from the deficit. Today a reasonable guess might be a 20% chance. Still not odds-on but approaching a point where we have to become aware of the deflationary effects of budget cuts of that magnitude.
And with that longer-than-usual introduction here is ZeroHedge from three weeks ago, January 19, 2025 with a mathematical wrinkle in the perceived inflation rate.
Annualized inflation growth is on the verge of falling apart…
Early in my career, I was fortunate enough to work with some very sharp people. The firm I worked for had hired a team from one of the oldest investment banks in the country. Many of these people had spent much of their careers working for the same firm. But the company had sold itself to a foreign entity and they were moving headquarters somewhere else. So, when they joined my firm, they brought generations of passed-down business wisdom with them.
It was such a successful investment bank because it made sure the people who worked there employed best practices in everything they did. One of those habits was always being proactive instead of being reactive. The employees challenged each other to act and think about where the environment was headed. That way, they were always prepared for any challenge that lay ahead.
And the longer I spent working with the group, the more I saw these habits pay off. The research analysts, salespeople, and traders always seemed to be a step ahead of the market. Because they spent so much time studying, analyzing, and understanding, they were better able to help their clients prepare for every environment. And in the process, they made complicated situations seem routine.
Recently, I’ve been reminded of those habits I learned and now employ. Yesterday, the talking heads in the financial media were in a panic about the December consumer price index (“CPI”) data from the U.S. Bureau of Labor Statistics (“BLS”). Some of the commentators on CNBC labeled the increase in annualized growth a disaster.
Yet as I stated back in November, the pace of growth would increase into year end, before rapidly fading in the first part of this year. And as the shift happened, it would likely catch the markets and financial media off guard. Well, based on yesterday’s numbers, the rollover should soon start to happen. And if annualized inflation starts to drop as I expect, it will lead to a steady rally in the S&P 500 Index.
But don’t take my word for it, let’s look at what the data’s telling us…
This past week, the BLS reported its headline consumer price index rose 2.9% on an annualized basis. Now, while that was in-line with the consensus expectation, it was an increase compared to the November gain of 2.7%. So, it appeared that price pressures were rising.
Compounding matters was the way monthly growth is reported. The BLS releases the data on a seasonally adjusted basis (accounts for things like weather). That number showed a 0.4% increase for December. It was the highest reading since April and double the number from November. The implication being that inflation growth is accelerating, hence the media reaction.
However, those outlets weren’t digging into the entire picture. To get a better sense of how the headline-annualized numbers are shaping up, I like to look at the non-seasonally-adjusted numbers (raw data). After all, that’s how the annual numbers are reported. And according to those results, inflation growth was unchanged in December compared to November...
So, the numbers drawing the headlines made inflation seem like it's heating up. But when we focus on the non-seasonally-adjusted data, we see something different taking place.
Like I said at the start, there’s a shift taking place because of the way the yearly numbers are calculated. You see, it’s a sum total of each month’s growth. By looking at the above chart, we notice the numbers from January through April of last year ran hot. But ever since, they’ve been trending lower. And moving forward, those high numbers from last year will start disappearing when the January data’s released. That means the pace of annualized growth could start to cool rapidly...
In the above table I’ve highlighted the numbers in two different shades. The red ones are the hot numbers, indicating inflation is picking up, while the green numbers tell us price pressures are cooling. If we add the data up from January through April, we see that it accounted for 2.1% of the 2.9% growth over the last 12 months. That means that May through December only accounted for 0.8%.
But to get a sense of the trend moving forward, we can observe the six-month average. Because, that number removes the older data that’s about to disappear. And according to the result, the pace of monthly inflation growth since July has averaged just under 0.07%. That works out to just 0.9% on an annualized basis....
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We'll get an indication of the correctness of this analysis next week and over the next six to twelve weeks we'll get a feel for the Fed's intentions vs. the data and vs. the Administration.
Earlier:U.S Debt Clock Now Has A Number For DOGE Savings