#963 - Is Everyone Too Complacent About Inflation? With Dr. Komal Sri-Kumar

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0:35Is everyone too complacent about inflation? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Dr. Sree Kumar, president of Sree Kumar Global Strategies. Hi, Sree. How are you? Good to be with you, Maggie. Good. I love having you on Fed Week because there's a lot to talk about. We have treasury yields inching lower again ahead of the Fed meeting. And it seems like the market is expecting some kind of dovish message or posture, maybe even a hint at a May rate cut. What do you expect from J-PAL this week? I'm expecting that it will be relatively dovish, and I will be actually as an economist and a guy who cares the best for the economy, I would wish he does not repeat his speech of December 13th, when at the press conference, it was already the market was a rocket ship going up, and he lit it up even further, and he sent it into space with his dovish talk.

1:34That's not what we want from a Fed chairman at this stage. Inflation is still above target. We have lots of geopolitical uncertainties around, and I think it behooves the chairman to put more caution into his talk. Now, the question is, is he going to do that? I would be happy if he doesn't come out very dovish, even if he's balanced, Maggie. But what I'm expecting is that he will definitely not sound hawkish tomorrow. So it's interesting. I mean, they are trying to walk a really fine balance, aren't they? One of the things they've said repeatedly, even in his last, you know, very dovish delivery, of course, that's because they put the rate cuts on the dot bot, right?

2:21The radar. They sort of said that. So everybody declared that the pivot. But they've said and kind of came out consistently in speeches afterwards saying, listen, we have time. We're going to take our time. We don't want this to be the 1970s. But the sort of camps are divided again. And there are people who are concerned about that. And there are people who say, listen, these inflation numbers are coming down like a rock. I mean, it's time. Don't wait too long. How do they sift through these balance of risk? Do you think they'll actually wait? I mean, the market has something priced in five rate cuts.

2:59So if that's going to hold true, they expect them to start delivering pretty soon. How do you balance that? How should we be thinking about inflation? Because that seems to be key. First of all, it is very difficult to do the balancing given that you had very different approaches from Powell on December 13, and from John Williams, the head of the New York Fed, often considered to be the second most powerful person in the Fed hierarchy, he immediately said the same week that you should not expect quick rate cuts and a March rate cut expecting is premature. And we had a number of other Fed governors and presidents of regional banks who repeated the same statement.

3:46So there has been a lot of confusion in terms of what the Fed is going to do. So in terms of how the market participants should be reacting to, you should not expect a rate cut in March. I think even for the most dovish members within the Fed, that would be excessive. But I think May, June, they will start to talk in terms of rate cuts taking place, that is where I think you have to watch how dovish it gets. Tomorrow is not going to be very much of a newsmaker in terms of rate cuts. Where are you going to see something significant tomorrow will be any statement that is made about the pace of quantitative tightening.

4:30To give you a picture, Maggie, this all began with the increase in the balance sheet when Lehman Brothers failed in September 2008. The Fed's balance sheet was a mere$800 billion. It was the equivalent of about 5 % of US GDP. That is 2007-2008. Look at it today. The balance sheet is$7.7 trillion. The US GDP is about$24 to$25 trillion. So we are at about 25 % of GDP and the Fed is thinking in terms of stopping the QT and essentially not cutting the balance sheet further. So what they are telling you is they are going to leave you at more and more easy situation with respect to the Fed. And I think that is dangerous for inflation and that's something investors should consider as well.

5:29Let's talk about that a little bit. So you do think that maybe the market is too complacent about inflation because, I mean, this is, you know, you listen to most people, even people who worry that the market's ahead of themselves on rate cuts kind of acknowledge, listen, inflation is headed down. I mean, inflation seems to be, we seem to be past that point. What would cause the inflation to come back? What would it look like? Where would it show up? What time frame? What do you worry about with that? I'll answer you. That's a great question, Maggie. Let me answer you in two or three parts. First of all, controlling inflation, bringing it down when you look at sectors is more like a whack-a-mole game.

6:11You hit on one side, it goes down, and then it comes up again elsewhere. But the major difference has been initially with COVID, the inflation came in goods, not in services. You did not go take plane ride. You did not go stay in hotel, and you didn't go to restaurant, but you bought a lot of goods at your home. preferably delivered at home. At that cost, the goods prices to shoot up because the demand was focused on it. Since then, we have had goods inflation going down. Sometimes even the price level has gone down and the inflation has shifted over to services and more and more services are getting affected.

6:54I think we are now approaching a third stage, namely, there are some components of goods such as fuel, which have come down significantly in price, and food, where the inflation is also lower than COVID days, which are going to reignite. The reason, we have famines in different parts of the world due to the El Dino phenomenon, that's the weather-related, and we have so many wars going, and any of those could push up energy prices. So those are the areas I I think you want to be talking in terms of inflation picking up. So I'm saying that you've had the best time possible in terms of inflation mitigation, but it behooves you not just to extend, present, and then extrapolate to the future.

7:42You should look to see what could go wrong. And so many things appear negative in my eyes. Well, extend and pretend is a very popular pastime. He stays in many parts of the investing and economic landscape. But if that is the nature, and you're absolutely right, it does feel like whack-a-mole. We only have to look at the news headlines to understand the connection. We see the Red Sea blocked off from shipping. It's very clear. But correct me if I'm wrong. I thought that the inflation that the Fed or that central banks were more concerned with was what we call sticky inflation, that kind of inflation like wage inflation, which tends to never reverse, never mean revert, and that you can't roll back and then creates a spiral of ever chasing prices higher, incomes higher.

8:34That's in their purview to effect when they have interest rates. Can interest rate policy impact things like supply disruptions? Wasn't that what the whole transitory conversation was about? Conversation was exactly that. You're right. Interest rate policy is supposed to act on demand. It cannot create more food. It cannot bring more fuel into the country. But what it can do is to restrict your demand for food, restrict your demand for clothing or fuel. So that's the way interest rate policy works. With higher interest rates, you're not able to buy a home. With higher interest rates, you're not able to get a loan to buy a car.

9:16And that's supposed to restrain demand. The problem is, I think the distinction between demand and supply and what interest rates can work with is often misused. What do I mean by that? If you do have a supply disruption, as we had in 2020, 2021, it behooves the Fed, in a sense, to also not feed it by increasing the money supply and cutting zero into interest rates to zero as we did. because if there is a natural phenomenon that the food supply is reduced and supply bottlenecks develop, collectively, the society has to cut its demand and the Fed cannot come forth and artificially boost the demand.

10:01Why is that? If it does it, the Fed never knows how to cut back again. And once it leaves you at a much higher level of demand, much higher level of liquidity from which you never back off. Take the case of quantitative tightening. Now the balance sheet is more than 25 % of GDP and they don't want to stop quantitative tightening. They want to be able to end the balance sheet reduction instance. So those are the problems I think we are going through. Hey everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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11:46Yeah. And it's a great point. I mean, obviously when we were in COVID, no one was working, people had to live. There was a different calculus to the decisions that were made. Now that we're in a more normal time, if you see that sort of sporadic inflation, the idea that you would juice it. So maybe it's not in the toolbox to eradicate it, but the idea that you're artificially pushing up demand - Exactly. The stimulus makes a lot of sense. And that's a really important distinction, I think. So we have a question that mirrors what I was thinking about. Oh, so many have come in. I've got to go down and find it.

12:24From the Macro Butler. Thank you guys, by the way, for putting such great questions in all the time. We love our chat. If you're not on the platform, come over and join us. You can sign up for free. He's asking or she's asking Sri Do you think the US economy is heading into stagflation After the presidential election As government spending could fade after that I mean it's an interesting question Especially when we're grappling with this inflation Potential problem How are you thinking about the outlook for the US economy? That's a great question from the member of the audience Maggie I would tell him or her that I was forecasting stagflation in 2021.

13:07And I wrote in my weekend reports that 2022 was going to be a difficult year. We saw for a while that you lost money in both bonds and equities. That's what happens in a stagflation. Stagflation involves inflation in which bonds lose value. Stagflation involves slower growth in which your equities lose value. so you lose money on both. 2022, I think the Fed essentially charged the economy up. We came back with equities and fixed income doing well toward the end of the year. In answer to the person's question, what happens after the elections, my guess is you are going toward a recession, whether it is a few months before the elections or a few months after.

13:57But as to whether that recession is combined with inflation picking up would depend upon what role fiscal and monetary policy are going to play. My guess is after the elections, you don't care so much about the recession. You have either won the election or you have lost the election, and there is no immediate pressure politically to change. So I'm going to say very guardedly, cautiously in answer to that question, you're probably going to have a recession very likely soon, but it will not be a stagflation like I forecast in 2020 and 2021. everyone. And, you know, I think that it's always important as we go through the election.

14:40First of all, we all have to really check ourselves and think and use our minds about what we're seeing and reading. But there's also the promise of everything. And then there's actually passing legislation. So you could have people say, promise you they're going to spend fiscal money every which way, but they actually have to do it. And as we know, Washington's pretty gridlocked, pretty dysfunctional right now. Right. Exactly. The promise of fiscal and the actual spending of that fiscal money are two different things, which we have to keep an eye on. Great question. By the way, there was such an interesting headline that just crossed when we're talking about consumers and inflation and what they do with extra money.

15:16I have not fact-checked this. I'm just reading it blind on air. So just take that into consideration. Austin experimented, the city of Austin experimented with giving people$1 ,000 a month and they spent it on housing. Isn't that interesting? I think it shows how much that a couple pieces of the cost of living just so affect so many people. You can go out and spend it on stuff or on luxury or whatever, on experiences. They spent it on housing. My guess would have been health care, but that's probably a close second. So this is another fantastic question from Chad. Finally, waves of layoffs are being announced and unemployment may rise up.

16:08How will this factor into the Fed's view on inflation risks and rate cut schedule? And that's an important one to ask because we've seen this. The team and I behind the scenes have been talking about this steady drumbeat of layoff announcements. UPS is the latest today, 12 ,000 people. But they've been pretty frequent. They're not getting a lot of pickup on, I would say, sort of a national news level. It tend to be more localized where it's happening, where the companies are headquartered. But we have seen companies very quick to lay off people. How does that impact the Fed? So far, that part, the layoff news is coming anecdotally, as you mentioned, with UPS being the most recent.

16:54But on the other side, the macro numbers are suggesting the number of open jobs available, which was published today at 10 o 'clock Eastern time. It is known as the JOLTS report and also comes from the Bureau of Labor Statistics, showed that you have 9 million open jobs which are currently available. At the same time, every job on average in the United States has only 0.7 worker available to it. Or the reciprocal of that, every worker has 1.4 jobs available to him or her. So it means that you have more than one job available per person, and that by itself should show you that there is a problem.

17:42Now, why is there a layoff at the same time? I have an explanation which I have again talked publicly about. It's a skill mismatch. So if you're working for a company and you have certain skills which the company management does not value, you may be looking for a job. They are opening up a job, but the two of you don't match. So it is going to add up to an increase in the unemployment rate. So if you have to come to bring down the unemployment rate, you also in the long term need to put emphasis on education. Whereas look at the post-COVID stimulus. I like to say that when Ben Bernanke came in in 2008 and then increased the money supply substantially, he did not change a plumber into a nuclear physicist because the money supply doubled or tripled.

18:40The plumber is still a plumber. So the point here is you need the skills which are very much in short supply in different areas, and they are not provided by the stimulus. So I think what's going to happen is that you're going to see more layoffs. They are going to translate eventually into a higher unemployment rate, although they have not. And the experience that we have from 2007, 2008 is once the unemployment rate starts to rise, it increases very rapidly. So if you are at 3.7 % unemployment rate now, don't be surprised if in three or four months you reach 4.5 % and soon you're hitting 5 % as the recession becomes a reality.

19:26Yeah, that's a fantastic point. And you're right. And this is another area of, let's just broadly call it public policy, which we have not exactly been hitting the ball out of the park, trying to figure out how to how to skill a workforce or even what a workforce looks like in the future. By the way, completely related to that, we were waiting for big tech earnings after the close. Microsoft looks like it beat estimates as Azure grows faster than expected. That's the headline. We know Microsoft has been at the forefront of this AI revolution that we're just in the early innings of. Looks like Microsoft is up a little bit to flat.

20:03A lot of times, everyone wants to listen to the conference calls as well. So those details just crossing will keep you posted. in. I think a lot of people wanting to hear what they have to say and just how profitable AI. So there's two questions, right, Sri? There's what does AI mean for businesses, for the bottom line? Does any CapEx spending they're doing and it translate into actual revenue? That's an investor question. For society, there's a question and what the impact on the economy. And when we're talking about jobs, how unemployment's affected, this is a big unknown for everyone, including the Fed.

20:38They're trying to extract themselves from unprecedented policy that's still left over from the great financial crisis, where they kind of made a whole new rulebook and facilities. And now they've got this technological revolution layered on, which we don't know how it's going to impact jobs. We don't know how it's going to impact productivity. And that's another piece of the pie. We talked about this on Real Vision. It didn't get a lot of traction, partially because it came out before the holidays, but we saw productivity explode last quarter, right? Highest in three years. How does that plug into how you're thinking about the economy, especially because we don't know what AI is going to do to productivity or if it's feeding into that at all?

21:22Because high productivity is a good thing for an economy, right? Right, exactly. Let me, again, I have two parts to my answer. First part, productivity. AI development is going to be immensely helpful for productivity. But also keep in mind, AI is disruptive. Disruptive in the sense that if you're used to be doing your job in your way for the last 20 or 25 years, where AI comes and makes that job so much easier to do, and for somebody else to do it at less cost than you, you have to find out either whether you can develop a new skill alongside AI, or you don't have a position. So productivity increases, it allows for people who have the skill to enjoy phenomenal wage increases.

22:14So for instance, average hourly earnings have been increasing at 4.1 % at the latest figure. And because of the AI boosted productivity increase, you were able to have an inflation rate It's still somewhere in the 3.5%, 4 % range. You are not having inflation much higher than that, which you would have had with a 4.1 % wage increase had you not had the productivity surge coming from AI. So that's the one good part. We are already seeing the beneficial impact of what has happened. The second thing I would say is that in terms of productivity improvement and inflation, you will find that you have to keep on improving the productivity in order to keep the inflation rate low.

23:05So if you don't have changes, then the benefit to it is going to end. The comparison I would make in terms of productivity, employment, is what we saw happen when laptop computers came into being first the big, clunkety, huge size in the 1980s. And then the size became smaller and smaller. Then people said, well, computers mean I will not have a job anymore. But what they find is if you could work with a computer, you could do a lot more than you could do before. So it enhanced your productivity, created new employment. That, I think, is what's going to happen with AI. Namely, people who are able to harness it, who are able to use it for the benefit, are going to be able to get so much more done than people who find it as a threat or a competition.

23:59We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

24:10That's so interesting. And you're so right. There are two sides to that. Exactly why we spend a lot of time talking about AI and looking at the exponential age and how it affects the economy and markets, but also how we interact with it and what we need to know and sort of continue to grow our sort of learning curve about it. I have to read this comment from Beau. Bo, it made me laugh, but it's so great. The NBA had a Dr. J. I think as far as the markets are concerned, we have Dr. K. So we agree. And I love that, Bo. Thank you for that. Thank you. Thank you so much. I want to get your thoughts, Sri.

24:45We have a really good question about China. So I want to get to that. So as we now have a pretty good sense of the things that are on your mind for the US economy, what are you thinking about the 10-year bond yield? Where do you think bonds are going? Well, 10-year yield today is around 4.05. My expectation is that it is still going to be a good investment vehicle. If you have the next two to three years in mind, when the 10-year recently traded at 4.5, it went over 5%, I said it is not going to hit 6 % or 7 % like some bond pessimists have been saying. Why? Because by the time it goes to that higher level, something will break in the system and that will bring the treasury yields down.

25:34That's going to be your place of safe haven. So even at 405, I find it very attractive to be in 10-year securities. And that would be, I think, one of the areas that I would go into in terms of protecting myself. So either way, they're moving lower. We have to hope it's for a good reason and not for a financial blow-up reason. Right. But I do worry, though, Maggie, that it is not going to be inflation going down to 2 % and staying there. That's going to bring down the 10-year yield. It is going to be whether a problem with another bank failure, whether it's a problem on the commercial real estate side, or it happens on the credit crunch, or as we saw in September 2019, we had with quantitative tightening taking place at that time, in taking baby steps between 2017 and 2019, the short-term money market suddenly blew up.

26:34The interest rate shot up. And essentially, the Fed stepped in and said they stopped quantitative tightening and moved over to quantitative easing. So that's, again, one other way in which you can have a change in policy. And that might also lead to lower Treasury yields. So anything bad happening on the economic side is going to be good for the U.S. Treasury. Good for U.S. Treasury. What about U.S. stocks? Doesn't sound like any of those scenarios are good for U.S. stocks. None of those scenarios. There is one scenario which is actually very good. I've been saying U.S. equities, once they get a hit because of a credit even, are subsequently going to rally when the Fed and Treasury turn on the fiscal and monetary taps and the faucet turns on and you're going to say, forget about inflation.

27:24We only need to care about the system and we are going to turn it on. In other words, think about December 2008 to March 2009. Interest rates have just come down to zero. We are waiting and the S &P 500 is heading to its all-time low of 666 in early March of 2009. That's the time there was blood on the street. That's the time to be very optimistic because it turned out to be the bottom for equities as well. So that's where I would watch to see something breaking, allow for a little bit of time to go by, and then watch for the stimulus to pull up the equities again. But you don't think it's anything as cataclysmic as what happened during the great financial crisis?

28:10No, I don't think so. It doesn't look like it unless it's grossly mismanaged, which I would not put beyond scope of reality. But at the normal course, it should not be as bad as it was in 2007, 2008. Gee, the possibility that it could be mismanaged fills me with fear, I will say, given again what we see happening on a daily basis. So Ralph asking, I want to get this in because it's not just about the U.S. We often spend a lot of time talking about that because it kind of is one of the lead dogs and has huge repercussions, not just because we're sitting here, but China, massively important. Ralph asking, do you have any comments on China generally and its real estate sector specifically?

28:53We know the courts ordered Evergrande to be wound down this week. How are you thinking about China and that impact on the global economy? China, clearly there are a variety of issues. One is domestic economy-wise, the economy has slowed down. They have never recovered from COVID in a way that the United States and Western Europe did. There was no similar recovery in China. It's been very slight. The second problem they have is the communist administration in Beijing interfering with private businesses. When I say that, think Jack Ma, think Alibaba. Not only that, even think in terms of a pedestrian occupation like tutoring students to get into college.