Perma Bulls Cheer Powell's 'Miracle on the Potomac', but the Ground Below is Hardly Terra Firma
Powell's soft landing doesn't fix trouble on the groundJanuary 10, 2024
Fed Chairman Jeremy Powell is attempting to defy history with a DC version of Sully’s Miracle on the Hudson. Since World War II, the U.S. has never avoided a recession within 18 months of annual inflation falling from above 5% to below 3%.
Forecasters surveyed by the Federal Reserve Bank of Philadelphia predict just that, however. By the end of 2024, they say inflation will be 2.5% and real GDP will grow 1.7%. If that’s the case, Powell will have pulled the US economy out of a nose dive of runaway energy, food and goods price inflation without shearing the wings off. Through 11 interest rate hikes totaling 5.25 percentage points since March 2022, inflation will have leveled off back to normal rates of around 2% without the economy crashing into recession.
The market’s perma bulls are already talking 2024 rate cuts and signaling future exuberance.
Federal Reserve Bank of Richmond President Thomas Barkin cheered on Captain Powell’s efforts, but noted in a speech four alternative scenarios, extending the metaphor.
CNBC summarized Barkin’s speech saying, “The economy could ‘run out of fuel’ and growth could reverse; “unexpected turbulence” such as geopolitical events or the banking shock that hit in March 2023; the possibility of “approaching the wrong airport,” where inflation holds above the Fed’s 2% target; and a “delayed landing,” where demand holds unexpectedly high, boosting inflation.
A River of Trouble Awaits on the “Ground”
Barkin’s short-term warnings are sensible. But what he assumed incorrectly in his metaphor was that the plane known as the US Economy would be landing comfortably on an airport’s paved runway and taxiing to a gate, instead of splashing down into an icy river of trouble.
Reckless Disregard for Fiscal Management - The United States has been operating with reckless fiscal disregard for prudent fiscal management for more than 20 years. The US national debt was approximately $5.8 trillion in 2001 and will exceed $34 trillion as of the end of 2023. The national debt increased more than $2.6 trillion in 2023, up from $31.4 trillion at the end of 2022. In addition, annual interest costs on the national debt is now approaching $1 trillion annually and forecasts suggest that the federal debt will reach $36 trillion by this time next year.
Unsustainable Math of Interest Expense + Continued Deficit Spending - Our fiscal policy remains a significant issue that continues to raise concerns regarding the ability of the U.S. government to finance the deficit spending and the increase interest on the country’s national debt. The US credit rating was downgraded in 2011 by Standard & Poor’s from AAA to AA+ following congressional debate over the debt limit and the increasing size of the government debt. In August 2023, Fitch Rating announced that it had downgraded the US credit from AAA to AA+ as a result of erosion in confidence in our fiscal management. In November 2023, while Moody’s still rates the U.S. at AAA, Moody’s lowered the US government’s credit rating outlook from “stable” to “negative” due to declining fiscal stability.
Funding Shortfalls + Unmarketable Treasuries - The U.S Treasury will have to continue to issue debt in the form of Treasury securities to fund the shortfall in 2024 to finance the U.S. government deficits and interest expense. However, weaker demand in recent auctions has raised concerns regarding the impact of supply and demand for treasuries, potential further credit downgrades, record debt levels, and a looming federal financing deadline to avert a government shutdown in January 2024 following the second continuing resolution provide for an unusual converging set of issues for our leadership to navigate.
The Fatigued US Consumer + Tight Credit - Inflation and rate hikes have battered the US consumer. Rate cuts that may reignite inflation will further weaken an already fatigued consumer who faces higher interest rates and payments on credit cards, auto loans, rent, mortgages, and food. Inflation will also further increase the stress on the banking sector which is already struggling with impaired assets and recently leaning more heavily on the Bank Term Funding Program (BTFP) in response to deposit outflows. The balance outstanding under the BTFP now exceeds $131B and is set to expire in March 2024. An increase in inflation will further constrict the lending environment as banks are shrink themselves into healthier balance sheets and decrease bank profitability. This will adversely affect small and medium enterprises' lending, default rates, unemployment, and commercial real estate.
So…What Happens to the Airplane?
Whether it’s Chairman Powell or Captain “Sully” Sullenberger, we applaud a skillful landing through danger and the safe evacuation of passengers. But what about the plane itself? In this case, the U.S. economy.
The Airbus 320, aka US Airways Fight 1529, is now a relic in the Sullenberger Aviation Museum in Charlotte, North Carolina. Jerome Powell’s plan is cannot become a museum relic. It needs to be overhauled, gassed up and back flying.
The serious challenges the economy faces in 2024 from the fundamental failures of unrelenting deficit spending, accelerating national debt, and a weakened banking system must be addressed.
Chairman Powell’s job is to steer the U.S. economy. The fundamental fixes needed will have to spring up from other voices on Wall Street and in Washington. Perhaps something like the old bi-partisan coalition of Paul Tsongas/Warren Rudman who beat the drums for prudent fiscal management.
That would be infinitely healthier than more cheerleading about rate cuts from perma bulls.