Step 3: Chasing It

Macro Perspectives: Wed 09 Mar 22

We get February inflation data on Thursday, which will show something close to 8% year-over-year increase in CPI.

That's a hot number that will get a lot of attention - it will understate the current environment, considering the price of crude oil is up over 30% since the end of February. With that, next month, when we see the March inflation data, it should be double-digits - maybe even something in the teens.

And that would mean a plunge in this chart...

This is the January report on real disposable income (inflation adjusted). As we know, driven by the covid-related government handouts (three rounds of stimulus checks plus an overly generous and prolonged period of federal unemployment subsidisation), personal savings soared. Related to that, income spiked - as you can see in the chart.

Of course, now inflation is taxing not only that money, but all of your income (i.e. the blue line is going lower). Worse, by the time we see the February and March data incorporated into this chart, it will be falling farther, and likely knocked off of the path of the long-term rising trend.

That leads us to the next chart...

This is the spread between the 10-year and 2-year Treasury yields. This has declined to 23 basis points. When it goes negative (circled in the chart), recession has followed (between 6 and 24 months) all but one time dating back to 1955.

This brings me back to my July note of last year: "For now, we continue to ride the wave of asset prices. But the damage will come. First, from inflation and lower quality of life. And then, the economic decline is typically triggered by the Fed. When the Fed finally, 1) acknowledges the hot inflation, 2) stops fueling it, 3) starts chasing it, and 4) ultimately kills it with higher interest rates, then the economic damage will come.”

We're about to embark on step 3. The Fed's budding inflation chase would project a recession that would be consistent with the timeline from the yield curve analysis above.

That said, as we discussed last month, "if such economic disruptions (from Russia/Ukraine) unfold, we can be sure that the democrat-led Congress will quickly resurrect the "Build Back Better" plan to be rubber-stamped."

So, if this unfolds as such, we should expect more fiscal-funded agenda spending, disguised as a "rescue package." This fiscal profligacy would only reinforce the trend of devaluing fiat currencies, relative to hard assets (i.e. the commodities price boom).