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Will the Fourth Industrial Revolution Kill Inflation?

Inflation was up 0.5% in January and the CPI was up for 6.4% from the same period last year. Both numbers were higher than expected and have predictably caused the Federal Reserve to reflect and take a more hawkish stance. Shelter, Food and Energy remain the primary culprits boosting inflation numbers, of which shelter represents approximately 50%. While the markets anticipate a decline in shelter costs over the year this has proved stubbornly resilient to date. The next meaningful economic data announcements this month include "retail sales", the "monthly jobs report" and the consumer price index report for February.

You may be wondering why this article is titled "Will the Fourth Industrial Revolution Kill Inflation" and that is because we are on the cusp of paradigm shifting innovations which will unleash a "productivity revolution" unlike anything that has come before it. The combination of AI, Robotics and Quantum Computing to mention just a few will reinvent what is possible. The current Quantum Computer in development at Google is purported to be 158 million times faster than the fastest supercomputer on the planet. That is an unfathomable leap. AI (Artificial Intelligence) is expected to double in its capacity every 6 months. At the most rudimentary level, these technologies combined with advanced micro-devices that have the potential to monitor every item and point on any supply chain, will not only address "supply chain" imbalances but altogether drive logistical, material and sustainable efficiencies across entire industries. By addressing supply chain issues, one of the main contributors of inflation, we will see these technologies contribute powerful disinflationary forces.

However, while we are on the cusp of this 4th industrial revolution which has the potential to dwarf every previous industrial revolution combined, the current impact is in its infancy. Over time, the combination of the technologies mentioned, and many others have the power for generating exponential innovation and one of these changes will be a generative global disinflationary economic impact.

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Is the Economy Slowing? Realistic Interest Benchmark Forecasts May Signal the Beginning of a Reset

The end of "hope" may be a net positive when it comes to market expectations in a bear market. Up until recently the markets have been relying on a constant drip of an illusory - any moment now - "Fed Turnabout Cocktail". Each time the Federal Reserve dissappoints with renewed commitment to its hawkish policy, the markets pout. Volatility is the ineivtable result with almost daily commentary about the latest thoughts of the members of the Federal Reserve and upcoming economic indicators.

The markets have now - at last - factored in benchmark rates of between 4.9-5.4% which is closer to what the Federal Reserve has indicated as potentially possible. While markets and media talk about a pending recession in lock step with Federal Reserve policy, some argue that we are already in a recession. The markets are now factoring in or discounting the future on a more realistic basis which means a greater acceptance of what is likely and less hopeful about any imminent Federal Reserve policy turnabout. 

Federal reserve actions are slow to filter into the economy but as we mentioned in our previous article, there are signs of demand slowing appearing in the economy. Container prices which are seen as a more current indicator of economic demand have dropped from sky high prices of around $20,000 during the peak COVID era to the low $2-3,000 range today. Job openings are down substantially. Residentail real estate prices are falling. Commodity prices from lumber to copper are down from their recent highs. If it takes 260 hours for the world's largest supertankers to turn around, how much time does it take for the worlds largest economy?

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Recent Trends in GDP and Consumer Demand

The Fed Reserve and inflation have been primary market talking points. Today we will take a look at recent trends in GDP and consumer demand. While the Fed is doing all it can - with its tools - to put the breaks on consumer demand and inflation, the data - across multiple key indicators - shows clear signs that the economy is starting to slow.

After two consecutive negative GDP growth quarters, The GDPNow forecast for the the third quarter of 2022 has been falling steadily since August when it was projected at 2.5% to sub 0.3% as of last week, Tuesday. We will have a better estimate of GDP for the third quarter by the end of October. The trend and forecast shows consecutive declining growth.

The trend in slowing growth is also reflected by declining activity in inbound containers at major US ports. This is considered a coincident demand indicator and reflective of immediate shifting trends in consumer demand. Global commodity and food prices are showing some signs of price easing but remain high year over year. Jonathan Golub, Credit Suisse;s chief U.S. equity strategist maintains that: "Futures indicate that Food and Energy prices should fall -5.7% and -11.8% by year end 2023, while Goods inflation has declined from 12.3% to 7.0% since February,” he wrote. “Over the past year, Services and Rents are up less than Headline CPI (5.5% and 5.8% vs. 8.5%).”

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How Much Medicine is Enough to Shift Away from the Inflation Narrative?

"Inflation" numbers predictably continue to shape the market narrative. As you may have read in our previous blog posts we continue to see this being the case until the economic data starts to show a consistent declining trend. While markets will look for early signs that the tide is turning, only consistent data will mark a tangible shift in the markets and a change in Fed sentiment.

Until that time, the Federal Reserve will continue to hike rates aggressively. They have made it abundantly clear that this is their number one priority and while they would like to avoid a recession that is not going to sway their intent to bring inflation into their acceptable orbit of less than 2% per year. Given the significant monetary forces that were put in motion since the inception of COVID it may take more time and hikes than anyone would like or anticipates.

A good analogy is being at the dentist for an unpleasant procedure that takes more time to resolve. We want it to end but it won't until the dentist is satisfied they have done the job. The Fed dentist wont be done until they meet their objective.

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Will The Fed Doctors Administer More Medicine to Cool the Economy?

It appears that the Fed Doctors are leaning in the direction that more medicine is needed to keep the economy cool and inflation more tame.

We have maintained for many months now that this would be the Federal Reserve stance until the signs of inflation have shown a pattern of consistent decline. They failed miserably in quantifying the impact of their actions, inundating the economy in a sunami of close to zero interest funds and trillions of stimulus and now they cannot be seen to fail in bringing down "the inflation monster" they contributed in large part to create.

We expect the Federal Reserve to maintain a hawkish stance through this year and into the first half of the next year with the possibility of cutting the size of interest rate hikes as economic signs dictate. We then anticipate the Federal Reserve holding rates steady until a demonstrable period of time has passed indicating that inflation is more tame.

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