Can Heisenberg orchestrate a soft landing?

Happy Friday!

I wrote about the student debt forgiveness plan this week. It’s a third rail subject, so I tried to keep it as objective and economically/financially focused as possible. Skipped over the morality debate of whether it’s right or wrong because I’m not looking to trigger anyone, nor do I suspect anyone cares about my opinion on the matter.

And speaking of student loan forgiveness…

“I respect the strategy”

This is one of the greatest scenes from the best show ever on tv. It’s also how I feel about the political motivations of Biden’s student loan forgiveness program. 

This executive order is clearly meant to buy votes in November. There’s no reason to argue otherwise. Both parties buy votes every election cycle, so let’s chalk this up to politicians being politicians rather than one party’s morality being superior to the other’s. Now, let’s game theory this one out.

The Democrats have to know that this will likely end up in the courts. The question is if it will happen before or after midterm elections. 

If it’s after, then they got what they wanted. If it is overturned, who cares? Their goal was midterm votes, and that’s already in the rear-view mirror. If it’s not overturned, then they successfully passed legislation that’s popular with their constituency. 

If it’s before midterms and it gets overturned, the Democrats can use this against the Republicans. They can come out weeks or days before voting to target the moderates by telling them that the Republican Supreme Court is once again coming after them. First it was Roe v. Wade and now this.

Said another way, there’s zero downside risk for the Democrats and only upside. It doesn’t matter where you stand politically, you have to respect the strategy here.

Soft landing

There’s a great article by Greg Ip in the Wall Street Journal this week that discusses the possibility of a “soft landing,” or the outcome where the Fed kills inflation without causing a recession. He points out that soft landings have only happened when…

“…the Fed wasn’t trying to push inflation down; it was merely trying to keep it from going higher. At times like the present, when inflation was too high and the Fed set out to push it lower, a recession always occurred.”

Michael Cembalest at J.P. Morgan has a nice podcast out this week that discusses this very same topic. His research shows that soft landings have only happened when food and energy inflation are mid-single digits or lower. That’s clearly not happening today either.

But both sources are also smart enough to point out that there simply haven’t been enough data points to be able to draw any definitive conclusions. Furthermore, today’s economy looks nothing like those from the past, so history simply cannot be relied upon.

Both also suggest what we’ve been saying almost all year – the country is better prepared for a recession than any time in history. Personal and corporate balance sheets are stronger than ever, and operating margins and cash flow going into a downturn are higher and of better quality.

This should make any downturn – recession or not – far more manageable than what happened in 2008.

But there are some sources that claim the soft landing is not just possible, but that it’s already begun. One of them is Goldman Sachs, and their argument surrounds the weakness we’re starting to see in employment. 

We talked a few weeks ago about the Piper Sandler’s HOPE roadmap for how the economy responds to changes in rates. It goes Housing, Orders, Profits, and last to fall is Employment. Goldman is basically saying that the data over the last week or two indicate the “E” is starting to weaken.

Mr. Ip also highlights two very important points around inflation that the rest of the media has conveniently forgotten. First, the Fed doesn’t need inflation to fall back to 2% before they pump the brakes. They just need to see that it’s moving in the right direction. 

Second, inflation doesn’t need to fall all that much before they could reverse course. The media likes to report on the Consumer Price Index (CPI) because this basket of goods tends to report higher inflation numbers than its competing index, the Personal Consumption Expenditures Price Index (PCE).

But the Fed’s preferred measure is the PCE, and that was only up 6.3% in July, with core inflation at 4.6%. Both are lower than the CPI, so they don’t have to fall as far relative to the CPI to get the Fed where they want to be.

Enjoy the weekend…