Mid-Year Economic Review & Outlook
Disinflation has already been achieved & the economic warning signs are mounting
Fed tightening is having an enormous impact on the money supply & bank credit
An analysis of the changes that have occurred in monetary and credit aggregates show that the Fed’s tightening is having an enormous impact.
On an annual average basis, the M2 money supply is falling at the fastest pace since the Great Depression and bank credit is on the verge of turning YoY negative. This comes as commercial bank security holdings see their largest decline on record and as weekly loan & lease growth has fallen from a YoY high of 12.5% in December 2022 to 5.2% as of 19 July — recent trends point to further material falls in YoY growth.
CPI expected to be range bound, core CPI forecast to keep dropping in 2H23
In my latest update to my medium-term US CPI forecasts, I currently estimate that the CPI will remain range bound between 3.1%-3.6% in 2H23. For the core CPI, I currently expect an ongoing deceleration throughout 2H23, reaching 3.6% YoY in December.
Disinflation has already been achieved, but is being ignored
Failing to adjust for lagging rent based components is leading the Fed to ignore the fact that disinflation has already been achieved. To illustrate, in June, CPI rent of shelter was up 7.9% YoY, versus 0.0% for the Apartment List Rent Index. After adjusting for spot market rents, the CPI and core CPI were just 0.5% and 1.6% YoY respectively in June, and I currently forecast both to range between 0.5%-1.2% YoY during 2H23.
Cyclical employment, GDI and real imports provide major warning signs
While most are focused on a relatively low unemployment rate, the latest jobs report delivered a major warning sign, with the Economics Uncovered Cyclical Employment Ex-Manufacturing Index turning YoY negative in June. This index turned YoY negative 5 and 6 months ahead of the 2001 recession and GFC, respectively.
While the advance estimate recorded GDP growth of 2.4% in 2Q23, a deeper look at the GDP data reveals two key concerns: 1) GDI, which theoretically should be equal to GDP, is YoY negative — since 1947, this has NEVER happened without a recession; and 2) real imports are down 4.8% YoY — since 1970, real imports have never been this negative without a recession occurring.
With M2 seeing relatively large declines, underlying inflation having already dissipated, and cyclical employment, GDI and real imports all sending warnings about the state of the US economy, the bigger medium-term risk for the US economy isn’t high inflation, it’s the risk of a deflationary bust.
See the full 37-page report below:
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Steven, thank you for the great report this was an amazing weekend read. I have a question on Money Supply and Bank Credit: loan growth and and commercial bank deposits seem to be a lagging indicator based on all of the FRED charts. Wouldn’t the the decline in loans and M2 that were seen recently imply that the US entered a technical recession in late ‘22/early ‘23? Looking forward to your response!
Great insight!