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Lacy Hunt and Danielle DiMartino Booth on Liquidity and Problems the Fed Faces

Hedgeye TV presents an excellent video discussion of issues the Fed faces on bringing down inflation.
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Hedgeye TV Lach Hunt Danielle Booth

Danielle DiMartino Booth 1-on-1 with Lacy Hunt

Please consider Danielle DiMartino Booth 1-on-1 with Lacy Hunt

The pair discuss liquidity, velocity, the Fed PUT, QT, who inflation hurts most, the stock market sectors most affected, who inflation hurts most and when recession hits. 

Booth noted that housing prices are just starting to come down so headline CPI may be high into 2023. 

"This is a problem the Fed created for itself," responded Lacy. And due to the lag in rent adjustments, "the Fed is being hit by its tail." 

But Lacy went on to say "Inflation rate has clearly peaked and is heading downward." Many will disagree with that but I believe it's spot on.

Danielle commented that "It was intriguing to me that the assumption is that GDP would be 0.2 percent for all of 2022. Do you think they were broadcasting a message by taking the GDP down so far to where it's almost a rounding error and yet they remain as resolute as they are. Am, I reading too much into this?"

Lacy replied "No, I don't think you are. They did that for a purpose. They had a bad experience in June."

Lost in this discussion is the fact that following two quarters of negative GDP, the Fed's dot plot consensus of 0.2 percent GDP for the year is a big boost from here. 

My take was that the consensus forecast was wildly optimistic. The Fed just does not want to admit recession, yet. 

So, yes, I agree with Lacy, they did that for a purpose. But I see a different purpose, It's much easier politically to keep hiking rates if you do not forecast a recession, than if you do. 

That aside, Hunt was certainly correct that lovey-dovey comments to questions following the July meeting caused a stock market rally that the Fed did not want. 

"Another thing they did was talk of 4.4 percent unemployment for next year which as one reporter pointed out that implied job losses would reach 1.3 million people," noted Hunt. 

He added "the Fed is clearly braced, and they want participants in the market to understand this is an important fight that has to be won, and they are going to stay the course. Of course we don't know if they will stay the course, but currently they are on message. But it's going to take time."

Booth Asked Lacy the Key Question

Booth: "Can the Fed bring rates up and keep them at a high level, keep them at a plateaued level? Looking back at monetary policy we've never seen that happen."

Lacy: "No. I think that the odds are for a rougher landing for the Fed. If you look at Fed tightening since the Fed was founded in 1913, about 90% of [tightening cycles] resulted in recessions."

"The Fed can achieve a soft landing like they did in 1966 but those are pyrrhic victories that led to much more pain down the road. The likelihood of a soft landing is a low probability event. The Fed put themselves into this situation."

There's much more in the video, click on the above link to play it. Here's my take on the Fed's GDP forecast.

Examining Fed GDP Projections For 2022 and 2023

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Fed Economic Projections September 21, 2022

Please consider Wildly Optimistic Forecasts: Examining Fed GDP Projections For 2022 and 2023

Every Fed participant projects a soft landing scenario for 2022 and 2023.

GDP

  • Purposely and wimpishly ducking recession calls, the Fed never directly projects recessions. But from where we are now, their 2022 GDP forecast goes beyond wildly optimistic and implies no recession.
  • Nor does it appear there is a single recession forecast for 2023.
  • What makes 2023 somewhat debatable is the fact that Fed GDP projections are 4th quarter to 4th quarter so technically there could be a 2023 short recession followed by a rebound in the second half of 2023.
  • For 2022, it's clear. The Fed sees a second half rebound, not a recession as the following chart shows.

Real GDP 2021-2022

Real GDP in Billions 2022 Q2A

 GDP Projection Analysis (Numbers in Billions of Dollars)

  • Real GDP in the 4th quarter of 2021 was 19,806
  • Real GDP in the second quarter of 2022 was 19,699
  • For the Fed's 0.2 median year-over-year forecast to happen, 4th quarter GDP would need to be 19846 or higher.
  • That means real GDP would need to rise by 0.90 percent in the second half. And that would match the post-Covid GDP high.
  • Annualized, the Fed is projecting over 1.8 percent growth in the second half of 2022.

How likely is 1.8 percent annualized growth in the second half coupled with Fed rate hike projections given that the third quarter appears to be headed for a bust?

Dual Fed Message 

So yeah. There was a message. A dual message.

  1. We will keep hiking. 
  2. We will deliver a soft landing. 

One thing Lacy, Danielle, and I agree on is that #2 is not going to happen. 

So the Fed added to its credibility problem with those forecasts. But it is fearful of hiking while admitting recession, one I believe started in May. 

This post originated at MishTalk.Com

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