After the Shallow Recession, Will the United States Face Second Inflation? - Huxiu.com#
Its strategy should be to maintain high interest rates until the economy weakens and requires a rate cut. ⤴️ ^62737f41
- Considering the relatively healthy situation of the US household sector, it is very likely that this recession will be a shallow one. In other words, in the crises of 2008 and 2020, the maximum decline in the yield of the US 10-year Treasury bond was about 300-350 basis points, but this time it may only be 200 basis points.
- After this shallow recession, the rigid fiscal spending and the stimulus from interest rate cuts, especially the recovery of demand in emerging markets, will bring about a second round of inflation. ⤴️ ^2f9dc7b3
Does this mean that the economic crisis will be weaker than the crises in 2008 and 2020?
The first strategy for recession trading is definitely gold. ⤴️ ^f01e83e8
After the Shallow Recession, Will the United States Face Second Inflation?#
In March of this year, I wrote an article that had a very similar theme , and at that time, I thought it was the end of tightening. I thought that the risks brought by banks and the tightening effects of credit contraction would make the Federal Reserve feel that there was no need to raise interest rates.
The importance of this issue is self-evident. In history, and not just during the low interest rate period of the past 40 years, the Federal Reserve has often been more hawkish when raising interest rates than the market, and more dovish when lowering interest rates than the market. Therefore, the turning point from raising interest rates to not raising interest rates, from hawkish to dovish, is always crucial.
I will state my conclusion first:
- I think the Federal Reserve has completed this cycle of interest rate hikes, and as long as fiscal spending does not significantly exceed expectations, it only needs to be Longer to complete its mission. ==Its strategy should be to maintain high interest rates until the economy weakens and requires a rate cut.==
- According to historical experience, when the Federal Reserve confirms a turnaround, the yield of the US 10-year Treasury bond falls below the upward trend line, and the recession trading can begin. Currently, we are gradually approaching this moment, but there is still a little way to go.
- ==Considering the relatively healthy situation of the US household sector, it is very likely that this recession will be a shallow one. In other words, in the crises of 2008 and 2020, the maximum decline in the yield of the US 10-year Treasury bond was about 300-350 basis points, but this time it may only be 200 basis points.==
- ==After this shallow recession, the rigid fiscal spending and the stimulus from interest rate cuts, especially the recovery of demand in emerging markets, will bring about a second round of inflation.==
I know that it is very luxurious to discuss long-term issues in the present era, so the above views may change in a few months, but at this moment, I think we are experiencing a classic story of the world before the 1980s: interest rate hikes - shallow recession - increased fiscal spending - second round of inflation.
In fact, it is the same as Powell's Flag in 2019. He said that we have entered a new era, transitioning from the high volatility world before 1980 to the low volatility world now, with longer cycles.
In the high inflation world before 1980, the US cycle generally occurred every 3-4 years, with smaller amplitudes, and many were driven by fiscal and geopolitical factors. Or it can be said that during the 20 years from 1950 to 1970, every recession in the United States was influenced by geopolitical factors and wars.
So this is also consistent with the story we see today of the easing of tensions between China and the United States and the decline in inflation.
Now let's discuss these three things first, and then look at asset prices.
I. End of Tightening
The reason why March of this year was not the end of tightening can be attributed to three main factors:
- Residents' excess savings have not been spent;
- Businesses have not felt the chill of interest rate hikes;
- Most importantly, the impact of the increase in US bond issuance in June and September on interest rates was underestimated.
As can be seen, the debt ceiling was lifted in June of this year, and in October of the fiscal year, there was a sharp increase in US bond issuance. These two increases directly led to the rise in interest rates.
Charts for residents and businesses:
From this perspective: the Fed's interest rate hikes are coordinated with fiscal policy, rather than relying solely on economic data to make judgments. It can be better understood why the Fed was hawkish in May and July, because there were still many bond issuances to be done in June and September. The inflationary pressure brought by fiscal policy is unknown, and the Fed has a responsibility to contain inflation expectations when inflation is still far above the target.
From my point of view, I think the Fed's strategy may be:
- If inflation is above the target, then no rate cut is needed;
- If inflation is above the target and fiscal stimulus is still present, then monetary tightening is necessary.
So the first question is, will fiscal spending in 2024 decrease significantly? Currently, it does not seem likely. It seems that US fiscal spending in 2024 will not significantly slow down in terms of budget and logic. However, it is also difficult to repeat the significant growth of 2023, because the increase in the fiscal deficit in 2023, or the increase in absolute debt, is second only to 2020 in the past 30 years, more than 2021 and 2022. The Democratic Party has always liked to increase spending, but in an election year, I think they will face many constraints from both the Republican Party and within the Democratic Party.
This is one of my core assumptions, that is, the Republican Party will not allow the Democratic Party's fiscal spending to increase significantly, because as long as the Democratic Party continues to implement fiscal policies, the economy will not be very bad, and the Republican Party will face greater difficulties in the elections. Conversely, as long as they impose some constraints, they can reduce the difficulty of their own elections, and it is easy to do more harm than good.
So my first conclusion is: Fiscal spending in 2024 will not increase significantly compared to 2023, so the Fed does not need to continue raising interest rates at 5.5%, it only needs to maintain the current level. Residents and businesses will gradually weaken, government fiscal spending will remain stable, resulting in a mild recession for the country and a retreat for the people.
II. Shallow Recession
In theory, any deep recession starts as a shallow recession, so the key to judging whether an economic crisis is deep or shallow does not lie in whether it will occur, because it will always happen. The key lies in whether there are effective rescue measures that can reverse the situation at the early stage of the crisis.
As long as the crisis is contained in its infancy, it is a shallow recession.
I personally think that there are two reasons why 2024 is more likely to be a shallow recession:
- Whenever the Democratic Party sees the signs of a crisis, they will try to provide assistance. The Republican Party can constrain the Democratic Party's regular spending plans, but once a crisis occurs, it becomes easier to blame them if they continue to constrain. Therefore, the assistance from the Democratic Party in a critical moment is likely to be approved;
- Currently, the most dangerous sectors in the United States are those that have risks but also have remedies. It is not like in 2006-2007 when the leverage of the household sector was too high and consensus was needed for assistance. It is also not like in 2020 when the US government underestimated the impact of Covid.
Commercial real estate;
Small businesses and the unemployed.
Admittedly, all crises start small and grow bigger, but it currently appears that:
Government credit can be resolved through devaluation, small banks can be acquired by large banks, commercial real estate does seem to be in trouble, but compared to residential real estate, its owners are mostly institutions rather than residents, making it easier to provide assistance or acquire. Small businesses have always had a hard time in the United States, but this is the nature of capitalism. It took small businesses 3-4 years longer than large businesses to recover after 2008.
In my worldview, it is difficult to imagine a major recession occurring during a period of high inflation. In 2023, I remember saying at the beginning of the year that oil prices are the lifeline of this year, because if oil prices plummet and cause cost collapse, deflation expectations will follow, and EPS expectations will also disappear. As long as oil prices do not plummet in 2024 and inflation expectations do not significantly decline, I think the probability of a major recession is not high.
Currently, Saudi Arabia, Russia, and the United States do not want oil prices to plummet, and this is not the story of shale oil like before. Everyone has given up the obsession with market share and wants to make the last profit. This is similar to the story of coal. Once everyone gives up their ambition, the competition in the industry improves.
So for 2024, my basic view is: fiscal spending will not significantly exceed expectations, and if the economy weakens, monetary policy will provide some support. However, I do not expect a major rate cut in 2024. Risks will accumulate, and if the Fed manages inflation expectations in 2023, it may face the challenge of managing potential risks in 2024. I believe this mainly because the Fed has had a lot of ammunition over the past year and a half due to the rate hikes. And the possibility of long-term inflation has been opened up. With the support of deglobalization and populism, inflation is easier to achieve than deflation.
In short, I think the Fed has a lot of ammunition to deal with headwinds from residents and businesses. Therefore, even if there is a recession, I do not expect a major recession in 2024. Of course, the risk of this judgment lies in tail risks. For example, if another financial institution suddenly collapses, dragging down the entire market in a chain reaction, or if there are unexpected events in the many elections next year, they will challenge this assumption. Therefore, it is difficult to say whether it will be a shallow recession or a deep recession after the end of tightening.
III. Second Inflation
The long-term rise in commodities requires the combined forces of two things:
- Recovery of demand;
- Supply shortage.
I think the second point is difficult to solve in the short term because many people do not want to invest in commodities. This can be understood from the perspective of 2018-2021. Would you be willing to buy coal during that time? If you knew that new energy was the future, just like with oil now, if you knew that the transition to new energy was inevitable, would you buy oil? Even the Saudis themselves are not investing.
But because of this long-term surplus, there will be short-term shortages, and conversely, long-term shortages sometimes lead to short-term surpluses.
Creating is always more difficult than destroying. If you want to shut down an oil field or a copper mine, it is much easier than building one. If you establish an ESG standard and give low scores to investment institutions that invest in coal mines, oil fields, and mines, it is easy. Then they may not want to invest anymore. But if you find that investment is insufficient, and you want to encourage them to invest again, they need to consider not only the ESG score but also long-term expectations and short-term prices.
Destroying something is always simpler than creating something, so when destroying something, you must be very careful. Conversely, creation can be bolder. However, many foolish people do the opposite, they are cautious when creating and bold when destroying.
The cycle of rate hikes - shallow recession - second round of inflation has occurred many times in history, especially from 1950 to 1970. It often goes like this:
- Wars lead to fiscal spending, causing inflation to rise, and the Fed raises interest rates;
- When the war ends and demand weakens, inflation expectations decline, and the Fed cuts interest rates;
- New fiscal needs and new wars appear, fiscal spending increases, and a second round of inflation occurs.
The 1970s is a well-known example because the 1973 war and disturbances occurred in oil.
The above two charts represent a long-term cycle, but if you look at 1954-1960, corresponding to the 1958 recession, or the 1953 recession before that, it is also the same pattern.
So my hypothesis of second inflation is based on both economic factors:
- Many commodities are near their cost lines;
- Oil prices may decline, but the cost of oil has permanently increased because everyone is now trying to make the last profit instead of increasing market share;
- After the end of US interest rate hikes, the demand in global emerging markets may bottom out and rebound. As long as the US experiences a shallow recession, demand will not weaken in the long term. Even in a major recession, there will be a recovery in demand due to the fiscal stimulus in 2020;
- Commodity prices are easier to rise than to fall.
And political factors:
- From 2020 to 2023, there was intense confrontation between China and the United States, and inflation rose after the Russia-Ukraine conflict in 2022;
- In November 2023, tensions between China and the United States eased, and inflation may decline;
- In the future, the United States will still create conflicts globally, and inflation will rise again.
IV. Market Situation
In addition to the economy, let's talk about the market, and the most crucial aspect is US bond yields.
During the tightening cycle from 2003 to 2006, the yield of the US 10-year Treasury bond broke through the previous high and then declined. In the fall of 2007, interest rates were cut, breaking through the upward trend line.
During the rate hike cycle from 2016 to 2018, the yield of the US 10-year Treasury bond broke through the previous high and then declined. In December 2018, after Powell confirmed no more rate hikes, it declined.
In the current rate hike cycle, the yield of the US 10-year Treasury bond broke through the previous high, also a similar false breakout, and is still above the trend line. I feel that we need to wait until the Fed confirms no more rate hikes or actually cuts rates before the yield of the US 10-year Treasury bond falls below this trend line.
Of course, all of the above are assumptions, and if tomorrow the yield of the US 10-year Treasury bond falls below this trend line, then I think we should respect the market and engage in recession trading.
==The first strategy for recession trading is definitely gold.==
The above two points correspond to the position where the yield of the US 10-year Treasury bond falls below the trend line.
A very crucial consideration here is whether gold performs better or worse during periods of high inflation compared to periods of low inflation.
I think it is more likely to perform better because many people underestimate the commodity attributes of gold. Gold is at most a hedge against inflation when the economy is stable, but its safe-haven properties are stronger when the economy is unstable.
Copper generally does not perform well after the end of US interest rate hikes. It experienced significant declines during the periods of 2008 and 2020, falling below the cost line. However, it should also be noted that the oil prices during those times are not comparable to today.
I think as long as oil prices do not plummet, copper will find support around 7,000-7,500. If oil prices plummet, it's a different story.
As for crude oil, we will know in 10 days how OPEC views oil prices below 80. This will determine many things, including US bonds and commodities.
As for the US stock market, I think it will be a game between EPS and PE in the future. I still hold the view that if we consider the possibility of long-term inflation after a shallow recession, manufacturing and consumer stocks may outperform large tech companies in the next 10 years.
I didn't expect US fiscal spending to be so strong this year. The lesson learned is: even if I think the Republican Party will constrain the Democratic Party a lot next year, it is still necessary to monitor the US bond issuance situation every week.