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The Station: Rivian trims its workforce and a supply chain-tainted earnings season begins

The Station is a weekly newsletter dedicated to all things transportation. Sign up here — just click The Station — to receive it every weekend in…

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The Station is a weekly newsletter dedicated to all things transportation. Sign up here — just click The Station — to receive it every weekend in your inbox.

Welcome back to The Station, your central hub for all past, present and future means of moving people and packages from Point A to Point B.

Listen up founders! In a few months, TC Disrupt will kick off at the Moscone Center in San Francisco. This annual flagship event, in which hundreds of founders have pitched their startups on our stage, is back in person. So, here is a chance to participate.

Startup Battlefield 200 applications are closing soon. Apply today to join Startup Battlefield 200 for the chance to exhibit your startup for free at TechCrunch Disrupt this October and win the $100K equity-free prize. Applications close August 5. Apply today.

Next week, Rebecca Bellan will be taking over the whole newsletter show. Give her some love — aka tips and suggestions — by sending an email to rebecca.techcrunch@gmail.com.

You can also email me at kirsten.korosec@techcrunch.com to share thoughts, criticisms, opinions, or tips. You also can send a direct message to @kirstenkorosec

Micromobbin’

Supply chain constraints are not just hitting the automotive world. Micromobility is feeling the pain as well.

I reached out to about 20 companies building electric scooters and bikes, and most of them told me the same thing: Getting critical parts, like motors, out of China is becoming increasingly difficult, and Russia’s war against Ukraine is making supplies like nickel expensive and hard to source. The result? More companies are trying to get at least final assembly as close to the end consumer as possible.

Watch this space. We might begin to see new factories cropping up in Europe and North America, which will empower some economies even as others suffer.

In other news …

Arcimoto unveiled an electric tilting e-trike, which it calls the Cybertrike edition of its Mean Lean Machine, this week.

Dott brought in €32M in 2021, with about 19 million rides in 29 cities.

HumanForest did a marketing thing with dating app Bumble that was actually kind of cute. It gave people on Bumble access to 30 minutes of free riding to encourage people to try an active, outdoor date. 

TC’s very own Haje Jan Kamps tried out a prototype of the Nimbus three-wheeled, mini-EV. While it was a rickety little thing that is clearly not at all ready for public use, the vehicle has got real gumption, and Haje, like me, really wants to love it. Fingers crossed this company pulls off its final design when the time comes. 

Okai is launching a new fat-tire, off-road e-bike that can ride for 45 miles on dirt or road. 

Shell is making e-scooters and battery banks, I guess. Yes, Shell, the gas company that has helped us pollute the universe for over a century. 

Tier has introduced e-bikes to Ealing, in London, adding onto its existing e-scooter trial there. First time riders can get two free unlocks and 20 minutes of free riding using the code ‘EALINGTIER’ on the app.

A few words on bike lanes… 

A new study bike lanes increase sales of local businesses because they make the streets safer places for pedestrians, which increases foot traffic, so THERE! Shop owners should stop complaining to their local transportation authorities when parking spots get repurposed for bike lanes. The end.

Rutgers University researchers are using VR to help determine the feasibility of pop-up bike lanes in New Jersey.

Meanwhile in New York City, a bill is being considered to install bike lane cameras to catch when drivers park up in the bike lane and fine them $50. We love to see tech helping bikers stay safe.

— Rebecca Bellan

A little bird

blinky cat bird green

We hear things and we share the tidbits that we can verify.

We’ve been hearing rumblings for awhile that not all is right over at Helbiz, including that it was late paying employees in at least two offices – one in the U.S. and one in Serbia. The late U.S. payment was only about four days late, but Serbian workers were waiting on June pay until the second week of July.

This wasn’t the first time Helbiz was late to pay employees. In early April, the operator missed payroll for U.S. employees, blaming a software glitch. A former employee told us Helbiz also missed payroll in Serbia in December 2020, with employees not seeing a check until February 2021.

It seems the issues extend beyond late paychecks. Sources tell us that scooter supply shipments are also chronically late and complain the company is unstructured, causing issues in throughout the organization.

It’s certainly troubling, especially given the company’s plan to acquire another U.S.-based scooter operator, Wheels. If you recall from last week, we reported that Wheels employees are being furloughed. Back in late May/early June, Wheels furloughed “at least 10 people” according to one source.

— Rebecca Bellan

Deal of the week

money the station

After lots of back and forth, the JetBlue-Spirit Airlines deal actually happened.

The respective boards at JetBlue Airways and Spirit Airlines approved a merger agreement at a diluted equity valuation of $3.8 billion. JetBlue will acquire Spirit for $33.50 per share in cash, including a prepayment of $2.50 per share in cash payable upon Spirit stockholders’ approval of the transaction.

The deal faces scrutiny from the Justice Department. But if it closes, it will create the fifth-largest airline in the United States.

Other deals this week ….

Drover AI, the startup that really popularized using camera-based computer vision systems to stop scooter riders from riding all over the sidewalk, has closed a $5.4 million Series A.

Everrati, EV conversion startup, has landed an investment from former Nest CEO Matt Rogers, the Verge reported.

General Motors sold $2.25 billion worth of green bonds — at first for the automaker, Bloomberg reported.

Koenigsegg, the hypercar company, invested as undisclosed amount into Lightyear, the Netherlands-based startup developing a solar vehicle that is expected to go into production this fall.

Next.e.GO Mobile, the German manufacturer of compact EVs, is going public through a merger with blank-check company Athena Consumer Acquisition Company at $913 million valuation that includes debt.

Polymath Robotics, a new startup that came out of stealth and is part of the Y Combinator Summer 2022 cohort, has landed a number of high-profile angel investors, including Catapult Ventures managing director Darren Liccardo, Thursday Ventures general partner Matt Sweeney, Cruise co-founder and CEO Kyle Vogt and Oliver Cameron, the former co-founder and CEO of Voyage who is now at Cruise. (Polymath didn’t disclose the total amount of funding). Stefan Seltz-Axmacher, co-founder and CEO of Polymath is a familiar to the AV industry ecosystem. He previously co-founded and led the now shuttered Starsky Robotics.

Notable reads and other tidbits

Autonomous vehicles

Cruise has sent two of its autonomous Chevrolet Bolt electric vehicles to Dubai to begin mapping the city in preparation for a planned launch in 2023, according to Dubai’s Roads and Transport Authority.

Kodiak Robotics completed a commercial run between Texas, California and Florida for 10 Roads Express, as part of a pilot program with the USPS mail carrier.

Electric vehicles & batteries

Apple has hired Luigi Taraborrelli, a 20-year veteran of supercar maker Lamborghini, to work on the tech company’s not-so-secret electric autonomous vehicle program, Bloomberg reported.

Ars Technica released a guide to EV charging.

Bentley Motors has delayed its first EV.

General Motors launched a program and digital platform called EV Live to educate car shoppers about EVs and target first-time buyers, as the automaker searches for ways to catch up to and outpace rival Tesla.

Faraday Future is faltering— again. The company said in a regulatory filing that it has delayed production of its FF91 flagship electric vehicle due to lack of money and supply chain issues.

Rivian started laying off about 6% of its workforce (about 900 people) as part of a restructuring plan, according to an internal email from founder and CEO RJ Scaringe (and viewed by TechCrunch.) The layoffs are hitting every department with one major exception — manufacturing operations at its Normal, Illinois factory.

Sono Motors’ solar EV is finally here! Well, sort of; there’s the sticky business of production to contend with. The startup unveiled the final production design of the vehicle as well as a solar bus kit, a new product that is a series of solar panels designed to be retrofitted onto 12-meter public buses.

TechCrunch’s Tim de Chant takes a deep dive into the 725-page Manchin-Schumer bill, which includes some EV transportation spending. He also wrote up another TC+ (subscription) article examining whether VW’s new CEO will hamstring its EV push?

U.S. Department of Energy revived an old loan program and its first recipient is the joint battery venture between GM and LG Energy Solution, which received a $2.5 billion loan from the agency to help it finance the construction of new lithium-ion battery cell manufacturing facilities.

Ford released the law enforcement version of its all-electric F-150 Lightning truck.

Earnings

The big three U.S. automakers reported earnings this week and the big themes that repeatedly came up were inflation, supply chain issues, China and EVs.

General Motors kicked things off with a rather dismal Q2 report that saw profits fall 40% year over year to $1.69 billion. The culprit? GM blamed its weak performance on a drop in North American production due to supply chain disruptions and semiconductor chip shortages that caused bottlenecks at its factories. And let’s not forget the pandemic-related factory shutdowns in China.

Another tidbit: GM’s self-driving subsidiary Cruise is burning through cash with expenses hitting around $550 million compared to $332 million during the same quarter of last year. Operating losses topped $605 million, up from $363 million last year. The increase in cost can be attributed to a headcount increase from revving up Cruise’s robotaxi service, as well as a change in the compensation expense, according to CEO Kyle Vogt.

Ford also saw losses in China, but gains in other regions helped the automaker bring in $40.2 billion in revenue, a 50% increase from the same period last year and an adjusted operating income that tripled to $3.7 billion.

Spotify announced during its second-quarter earnings call that it has stopped manufacturing “Car Thing,” the company’s in-vehicle device for controlling music.

Future of flight

Urban Movement Labs in Los Angeles is partnering with South Korea’s Institute of Aerospace Industry-Academia Collaboration (IAIAC) to explore research opportunities around air mobility planning and integration. IAIAC is working to integrate advanced air mobility within the Incheon metro region.

People

Bosch is reorganizing its Mobility Solutions business sector, which will now be headed up by Markus Heyn.

Hyundai Motor North America promoted Randy Parker to be CEO of Hyundai Motor America effective August 1.

Lyten, an advanced materials company developing lithium-sulfur batteries and other high-performance product, hired Celina Mikolajczak as chief battery technology officer.

Ride-hailing

Uber is expanding its ‘Comfort Electric’ product, which is basically just all-electric Uber rides, to seven additional cities, including Las Vegas, Seattle, Portland, Denver, Austin, Philly and Baltimore. Uber originally launched the luxurious EV service in May in San Francisco, San Diego and Los Angeles.

Also in Uber news, the ride-hail giant apparently does not have to provide a wheelchair-accessible service in every market, a judge rules. This just a week or so after Uber settled a lawsuit from the DOJ for allegedly overcharging disabled riders.

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Government

‘Ding, Dong Inflation Is Dead’… But Probably Isn’t So Don’t Get Your Hopes Up Yet

‘Ding, Dong Inflation Is Dead’… But Probably Isn’t So Don’t Get Your Hopes Up Yet

Authored by Bill Blain via MorningPorridge.com,

“Inflation…

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'Ding, Dong Inflation Is Dead'... But Probably Isn't So Don't Get Your Hopes Up Yet

Authored by Bill Blain via MorningPorridge.com,

“Inflation is everywhere a misunderstanding of what actually caused it..“

The pace of US CPI inflation moderated slightly, but it’s too early for the market to conclude rate hikes are over. There are many imbalances still to resolve – especially in consumer credit. Meanwhile, the new UK premier’s clumsy attempts to blame the BOE raise questions.

Markets surged last night on the back of lower-than-expected US inflation. Markets globally rallied, anticipating a slowdown in the pace of Fed Interest Rate Hikes, and a resumption of the long bull Equity market. Bonds rallied. Joy, joy… joy..

Oh dear. It may be well to remember the Happy Munchkins in the Wizard of Oz singing Ding Dong, Inflation’s Dead…” but, that occurs right at the start of the film… before things get “challenging”. I’m not saying End-of-the-World.. just not-quite-as-rosy-as-you-hope!

The pace of US consumer price inflation fell to 8.5% y-o-y, down from 9.1% in June. It’s well to remember what the CPI number shows is fast prices are rising, not how much they have risen – it’s a subtle, but critical difference…

8.5% Inflation means prices are still rising, (Doh!), just less quickly than last month. Rising prices mean the Fed, and other Central Banks still have to address them. (Which is why expecting Central Banks to mellow rate rises/tighter monetary policy on a single snapshot number is a foolish hope.) 8% inflation sounds so much better than 9%, but it’s still inflation; an imbalance between supply and demand that prices are trying to correct. Result: central banks will keep raising rates to stun demand – if they are brave enough to court criticism from politicians.

The US number shows there are still significant inflationary pulses – and concurrent consequences – surging through the US economy. The lower number will focus analysts on just how quickly the inflation pace will start to fall. The oil shocks in the 1970s lasted effectively a decade. The first 1973 shock took around three years to abate, and was followed by an even stronger price shock in 1977 that took till the early 80s to resolve.

A one-month reversal in a longer-term inflation trend is not unusual – it’s far too early to say a one-month slight improvement in the pace of rising prices means the top has been crossed. But the inflation charts do show it is unusual to get consecutive months of declines, and then a sharp increase again. Its more common for inflation to remain stubbornly high for a number of years following an upspike. (That said… in time of “policy experimentation”, like 2010, an upspike was swiftly followed by a down spike.)

What the US CPI number did confirm is the US economy is in a very different place, and a different stage, to Europe and the Global economy. The key difference is the US report showed energy prices are normalising and reducing as petrol prices moderate. Jet fuel costs declined bringing down the cost of travel. In Europe – there is little chance of energy price moderation – if anything consumer energy bills will become increasingly chaotic and damaging to sentiment. Queue the great divergence between US and Europe – and what that means in terms of investment opportunities.

On the other hand; the US numbers show rising interest rates are impacting consumers cash, food prices continue to rise sharply while housing costs are also spiking. Ah… common experiences Europe and the US share.

The CPI numbers suggest the US economy is still in trouble. Over the past few months I’ve been watching things like Auto-loan delinquencies – as rates rise, and car prices surged on the back of availability and supply chain issues (primarily the shortage of chips), car financing costs became increasingly unaffordable. Auto-loan defaults are rising – but they have not become a crisis because – thus far – the used-car market can very quickly absorb repossessed cars. The reality is 20% of US autoloans go to sub-prime borrowers – who are the ones living pay-check to pay-check, and following years of declining real income (and now a crashing real-income shock) lack the financial resilience to keep paying.

Figures from the Fed show US Household debt is increasing – up 2% in Q2 2022 to $16.15 trillion (!). Officially, that’s because of repressed spending during the pandemic.

In reality, it’s cash-strapped US consumers are living off credit. Much of that credit is real: mortgage and auto-lending, but other numbers like credit cards and  from new DeFi lenders showing rising shadow-banking sector lending problems. The default crisis impacting lenders like Klarna comes on the back of cash-strapped consumers using credit to buy their daily milk, bread and petrol. You can’t repossess a bag of shopping.

The inflation driven economic threat in Europe is also about consumers. Years of low incomes, wage constraints, and job insecurity across much of Southern Europe leaves a massive number of consumers with precious few savings. The middle classes have been decimated by rising costs, consumer debt, and taxes.

(It’s a truism: if you can afford a lawyer and an accountant, you can avoid taxes… which is why tax gatherers, like the UK HRMC go for the weakest targets to collect unpaid dues. It takes less effort to extract a million in taxes from 10 struggling middle-class businessmen that it takes to get Amazon to pay a single cent. If there businesses collapse – so what, the tax got its money…)

Who is to blame for inflation?

The UK’s prime minister in waiting, Tank Girl Liz Truss ,says it’s all the Bank of England’s doing. Which is somewhat harsh.

  • I was unaware Bank of England Governor Andrew Bailey triggered the Russian invasion of Ukraine after first persuading Angela Merkle to close her nuclear plants and give German energy security to Vladmir Putin. `I though the Energy shock and food inflation shock were exogenous.

  • I was unaware it was Andrew Bailey who decided Tory MPS could give billions of govt money to their chums to not deliver functional PPE to the health service during the pandemic.

  • I was unaware it was Andrew Bailey who came up with (actually brilliant) furlough scheme to preserve jobs and consumer security (that was a very clever civil servant who has got zero credit for his efforts.)

  • I was unaware it was Andrew Bailey who set the government’s spending plans…

What I thought was Andrew Bailey and his colleagues at the Bank of England were maintaining a low interest rate economy to keep the pandemic economy functioning through the challenging pandemic years, and to keep the gilt market looking attractive so the UK Debt Management Office could continue to fund the Government’s funding schemes – all the while fretting about how to normalise ultra-low interest rates put in place to stimulate the economy in the 20-teens without destabilising everything.

Liz Truss doesn’t think so. That’s why she will not be getting my vote. (Not that I have one to give her.. but that’s not the point.)

The point is our next prime minister and First Lord of the Treasury will be chosen by 160,000 rank and file conservative party members. They are generally older, well-off, white, male and Eurosceptic. 63% are male. 80% are in the wealthy ABC demographic. 58% are over 55 and remember the Glory of Margaret Thatcher with religious reverence.

Which is why I think someone has been whispering in Tank Girl’s ear – I suspect the Minister for the Spanish Inquisition (Jacob Rees-Mogg). Now, Tank Girl wants to remove the Bank’s independence and replace inflation targeting with money supply targeting. Christ-on-a-bike: did I just drop through a worm hole into 1981? Big hair, shoulder pads, Duran-Duran and economic disaster…

I fear She opened the door into the Treasury’s Black Museum – and unlocked the box of Tragic Economic Mistakes, unleasing the Zombies of Monetarist Economic thinking like Mad Paddy Mitford (who says her plans are brilliant – unsurprisingly) and Tim Condon. Oh dear. Lord spare us…

If so, then we really are rubber ducked. Monetarism, ahem,  was such a success back in the 1980s – NOT! In the form of Thatcherism, the consequences are today’s broken Britain, the imbalance between London and the regions unknown outside the M25, the rebellious Scots and a host of long-term structural problems.

If someone had unleashed the Zombie Vampyres of Monetarism, then I’ll be sure to carry my crucifix, a sharp pointy wooden stake, and flask of Lagavulin (my holy water) when next in London.

Although its only August, the Christmas shops are already opening. I am tempted to write to Santa now. “Dear Father Christmas… I have been a very good boy all year. Please can we have a completely new UK Government?”

Tyler Durden Thu, 08/11/2022 - 07:20

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Spread & Containment

Will Powell Pivot? Don’t Count On It

Will Powell Pivot? Don’t Count On It

Authored by Lance Roberts via RealInvestmentAdvice.com,

Stocks are rallying on hopes that Jerome Powell…

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Will Powell Pivot? Don't Count On It

Authored by Lance Roberts via RealInvestmentAdvice.com,

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For fear of missing out on the next great bull run, many investors are blindly buying into this new Powell pivot narrative.

What these investors fail to realize is the Fed has a problem. Inflation is raging, the likes of which the Fed hasn’t dealt with since Jerome Powell earned his law degree from Georgetown University in 1979.  

Despite inflation, markets seem to assume that today’s Fed has the same mindset as the 1990-2021 Fed. The old Fed would have stopped raising rates when stocks fell 20% and certainly on the second consecutive negative GDP print. The current Fed seems to want to keep raising rates and reducing its balance sheet (QT).

The market-friendly Fed we grew accustomed to over the last few decades may not be driving the ship anymore. Yesterday’s investment strategies may prove flawed if a new inflation-minded Fed is at the wheel.

Of course, you can ignore the realities of today’s high inflation and take Jim Cramer’s ever-bullish advice.

When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.

Shifting Market Expectations

On June 10, 2022, the Fed Funds Futures markets implied the Fed would raise the Fed Funds rate to 3.20% in January 2023 and to 3.65% by July 2023. Such suggests the Fed would raise rates by almost 50bps between January and July.

Now the market implies Fed Funds will be 3.59% in January, up .40% in the last two months. However, the market implies July Fed Funds will be 3.52%, or .13% less than its January expectations. The market is pricing in a rate reduction between January and July.

The graph below highlights the recent shift in market expectations over the last two months.

The graph below from the Daily Shot shows compares the market’s implied expectations for Fed Funds (black) versus the Fed’s expectations. Each blue dot represents where each Fed member thinks Fed Funds will be at each year-end. The market underestimates the Fed’s resolve to increase interest rates by about 1%.

Short Term Inflation Projections

The biggest flaw with pricing in predicting a stall and Powell pivot in the near term is the possible trajectory of inflation. The graph below shows annual CPI rates based on three conservative monthly inflation data assumptions.

If monthly inflation is zero for the remainder of 2022, which is highly unlikely, CPI will only fall to 5.43%. Yes, that is much better than today’s 9.1%, but it is still well above the Fed’s 2.0% target. The other more likely scenarios are too high to allow the Fed to halt its fight against inflation.

Inflation on its own, even in a rosy scenario, is not likely to get Powell to pivot. However, economic weakness, deteriorating labor markets, or financial instability could change his mind.

Recession, Labor, and Financial Instability

GDP just printed two negative quarters in a row. Some economists call that a recession. The NBER, the official determiner of recessions, also considers the health of the labor markets in their recession decision-making. 

The graph below shows the unemployment rate (blue), recessions (gray), and the number of months the unemployment rate troughed (red) before each recession. Since 1950 there have been eleven recessions. On average, the unemployment rate bottoms 2.5 months before an official recession declaration by the NBER. In seven of the eleven instances, the unemployment rate started rising one or two months before a recession.

The unemployment rate may start ticking up shortly, but consider it is presently at a historically low level. At 3.5%, it is well below the 6.2% average of the last 50 years. Of the 630 monthly jobs reports since 1970, there are only three other instances where the unemployment rate dipped to 3.5%. There are zero instances since 1970 below 3.5%!

Despite some recent signs of weakness, the labor market is historically tight. For example, job openings slipped from 11.85 million in March to 10.70 in June. However, as we show below, it remains well above historical norms.

A tight labor market that can lead to higher inflation via a price-wage spiral is of concern for the Fed. Such fear gives the Fed ample reason to keep tightening rates even if the labor markets weaken. For more on price-wage spirals, please read our article Persistent Inflation Scares the Fed.

Financial Stability

Besides economic deterioration or labor market troubles, financial instability might cause Jerome Powell to pivot. While there were some growing signs of financial instability in the spring, those warnings have dissipated.  

For example, the Fed pays close attention to the yield spread between corporate bonds and Treasury bonds (OAS) for signs of instability. They pay particular attention to yield spreads of junk-rated corporate debt as they are more volatile than investment-grade paper and often are the first assets to show signs of problems.

The graph below plots the daily intersections of investment grade (BBB) OAS and junk (BB) OAS since 1996. As shown, the OAS on junk-rated debt is almost 3% below what should be expected based on the robust correlation between the two yield spreads. Corporate debt markets are showing no signs of instability!

Stocks, on the other hand, are lower this year. The S&P 500 is down about 15% year to date. However, it is still up about 25% since the pandemic started. More importantly, valuations have fallen but are still well above historical averages. So, while stock prices are down, there are few signs of equity market instability. In fact, the recent rally is starting to elicit FOMO behaviors so often seen in speculative bullish runs.

Declining yields, tightening yield spreads, and rising asset prices are inflationary. If anything, recent market stability gives the Fed a reason to keep raising rates. Ex-New York Fed President Bill Dudley recently commented that market speculation about a Fed pivot is overdone and counterproductive to the Fed’s efforts to bring down inflation.

What Does the Fed Think?

The following quotes and headlines have all come out since the late July 2022 Fed meeting. They all point to a Fed with no intent to stall or pivot despite its effect on jobs and the economy.

  • *KASHKARI: 2023 RATE CUTS SEEM LIKE `VERY UNLIKELY SCENARIO’

  • Fed’s Kashkari: concerning inflation is spreading; we need to act with urgency

  • *BOWMAN: SEES RISK FOMC ACTIONS TO SLOW JOB GAINS, EVEN CUT JOBS

  • *DALY: MARKETS ARE AHEAD OF THEMSELVES ON FED CUTTING RATES

  • St. Louis Fed President James Bullard says he favors a strategy of “front-loading” big interest-rate hikes, repeating that he wants to end the year at 3.75% to 4% – Bloomberg

  • FED’S BULLARD: TO GET INFLATION COMING DOWN IN A CONVINCING WAY, WE’LL HAVE TO BE HIGHER FOR LONGER.

  • “If you have to cut off the tail of a dog, don’t do it one inch at a time.”- Fed President Bullard

  • “There is a path to getting inflation under control,” Barkin said, “but a recession could happen in the process” – MarketWatch

  • The Fed is “nowhere near” being done in its fight against inflation, said Mary Daly, the San Francisco Federal Reserve Bank president, in a CNBC interview Tuesday.  –MarketWatch

  • “We think it’s necessary to have growth slow down,” Powell said last week. “We actually think we need a period of growth below potential, to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions. And those are things that we expect…to get inflation back down on the path to 2 percent.”

Summary

We are highly doubtful that Powell will pivot anytime soon. Supporting our view is the recent action of the Bank of England. On August 4th they raised interest rates by 50bps despite forecasting a recession starting this year and lasting through 2023. Central bankers understand this inflation outbreak is unique and are caught off guard by its persistence.

The economy and markets may test their resolve, but the threat of a long-lasting price-wage spiral will keep the Fed and other banks from taking their foot off the brakes too soon.

We close by reminding you that inflation will start falling in the months ahead, but it hasn’t even officially peaked yet.

Tyler Durden Wed, 08/10/2022 - 08:05

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Spread & Containment

Will Powell Pivot? Don’t Count On It

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For…

Published

on

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For fear of missing out on the next great bull run, many investors are blindly buying into this new Powell pivot narrative.

What these investors fail to realize is the Fed has a problem. Inflation is raging, the likes of which the Fed hasn’t dealt with since Jerome Powell earned his law degree from Georgetown University in 1979.  

Despite inflation, markets seem to assume that today’s Fed has the same mindset as the 1990-2021 Fed. The old Fed would have stopped raising rates when stocks fell 20% and certainly on the second consecutive negative GDP print. The current Fed seems to want to keep raising rates and reducing its balance sheet (QT).

The market-friendly Fed we grew accustomed to over the last few decades may not be driving the ship anymore. Yesterday’s investment strategies may prove flawed if a new inflation-minded Fed is at the wheel.

Of course, you can ignore the realities of today’s high inflation and take Jim Cramer’s ever-bullish advice.

When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.

Shifting Market Expectations

On June 10, 2022, the Fed Funds Futures markets implied the Fed would raise the Fed Funds rate to 3.20% in January 2023 and to 3.65% by July 2023. Such suggests the Fed would raise rates by almost 50bps between January and July.

Now the market implies Fed Funds will be 3.59% in January, up .40% in the last two months. However, the market implies July Fed Funds will be 3.52%, or .13% less than its January expectations. The market is pricing in a rate reduction between January and July.

The graph below highlights the recent shift in market expectations over the last two months.

The graph below from the Daily Shot shows compares the market’s implied expectations for Fed Funds (black) versus the Fed’s expectations. Each blue dot represents where each Fed member thinks Fed Funds will be at each year-end. The market underestimates the Fed’s resolve to increase interest rates by about 1%.

Short Term Inflation Projections

The biggest flaw with pricing in predicting a stall and Powell pivot in the near term is the possible trajectory of inflation. The graph below shows annual CPI rates based on three conservative monthly inflation data assumptions.

If monthly inflation is zero for the remainder of 2022, which is highly unlikely, CPI will only fall to 5.43%. Yes, that is much better than today’s 9.1%, but it is still well above the Fed’s 2.0% target. The other more likely scenarios are too high to allow the Fed to halt its fight against inflation.

cpi inflation

Inflation on its own, even in a rosy scenario, is not likely to get Powell to pivot. However, economic weakness, deteriorating labor markets, or financial instability could change his mind.

Recession, Labor, and Financial Instability

GDP just printed two negative quarters in a row. Some economists call that a recession. The NBER, the official determiner of recessions, also considers the health of the labor markets in their recession decision-making. 

The graph below shows the unemployment rate (blue), recessions (gray), and the number of months the unemployment rate troughed (red) before each recession. Since 1950 there have been eleven recessions. On average, the unemployment rate bottoms 2.5 months before an official recession declaration by the NBER. In seven of the eleven instances, the unemployment rate started rising one or two months before a recession.

unemployment and recession

The unemployment rate may start ticking up shortly, but consider it is presently at a historically low level. At 3.5%, it is well below the 6.2% average of the last 50 years. Of the 630 monthly jobs reports since 1970, there are only three other instances where the unemployment rate dipped to 3.5%. There are zero instances since 1970 below 3.5%!

Despite some recent signs of weakness, the labor market is historically tight. For example, job openings slipped from 11.85 million in March to 10.70 in June. However, as we show below, it remains well above historical norms.

jobs employment recession

A tight labor market that can lead to higher inflation via a price-wage spiral is of concern for the Fed. Such fear gives the Fed ample reason to keep tightening rates even if the labor markets weaken. For more on price-wage spirals, please read our article Persistent Inflation Scares the Fed.

Financial Stability

Besides economic deterioration or labor market troubles, financial instability might cause Jerome Powell to pivot. While there were some growing signs of financial instability in the spring, those warnings have dissipated.  

For example, the Fed pays close attention to the yield spread between corporate bonds and Treasury bonds (OAS) for signs of instability. They pay particular attention to yield spreads of junk-rated corporate debt as they are more volatile than investment-grade paper and often are the first assets to show signs of problems.

The graph below plots the daily intersections of investment grade (BBB) OAS and junk (BB) OAS since 1996. As shown, the OAS on junk-rated debt is almost 3% below what should be expected based on the robust correlation between the two yield spreads. Corporate debt markets are showing no signs of instability!

corporate bonds financial stability

Stocks, on the other hand, are lower this year. The S&P 500 is down about 15% year to date. However, it is still up about 25% since the pandemic started. More importantly, valuations have fallen but are still well above historical averages. So, while stock prices are down, there are few signs of equity market instability. In fact, the recent rally is starting to elicit FOMO behaviors so often seen in speculative bullish runs.

Declining yields, tightening yield spreads, and rising asset prices are inflationary. If anything, recent market stability gives the Fed a reason to keep raising rates. Ex-New York Fed President Bill Dudley recently commented that market speculation about a Fed pivot is overdone and counterproductive to the Fed’s efforts to bring down inflation.

What Does the Fed Think?

The following quotes and headlines have all come out since the late July 2022 Fed meeting. They all point to a Fed with no intent to stall or pivot despite its effect on jobs and the economy.

  • *KASHKARI: 2023 RATE CUTS SEEM LIKE `VERY UNLIKELY SCENARIO’
  • Fed’s Kashkari: concerning inflation is spreading; we need to act with urgency
  • *BOWMAN: SEES RISK FOMC ACTIONS TO SLOW JOB GAINS, EVEN CUT JOBS
  • *DALY: MARKETS ARE AHEAD OF THEMSELVES ON FED CUTTING RATES
  • St. Louis Fed President James Bullard says he favors a strategy of “front-loading” big interest-rate hikes, repeating that he wants to end the year at 3.75% to 4% – Bloomberg
  • FED’S BULLARD: TO GET INFLATION COMING DOWN IN A CONVINCING WAY, WE’LL HAVE TO BE HIGHER FOR LONGER.
  • “If you have to cut off the tail of a dog, don’t do it one inch at a time.”- Fed President Bullard
  • “There is a path to getting inflation under control,” Barkin said, “but a recession could happen in the process” – MarketWatch
  • The Fed is “nowhere near” being done in its fight against inflation, said Mary Daly, the San Francisco Federal Reserve Bank president, in a CNBC interview Tuesday.  –MarketWatch
  • “We think it’s necessary to have growth slow down,” Powell said last week. “We actually think we need a period of growth below potential, to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions. And those are things that we expect…to get inflation back down on the path to 2 percent.”

Summary

We are highly doubtful that Powell will pivot anytime soon. Supporting our view is the recent action of the Bank of England. On August 4th they raised interest rates by 50bps despite forecasting a recession starting this year and lasting through 2023. Central bankers understand this inflation outbreak is unique and are caught off guard by its persistence.

The economy and markets may test their resolve, but the threat of a long-lasting price-wage spiral will keep the Fed and other banks from taking their foot off the brakes too soon.

We close by reminding you that inflation will start falling in the months ahead, but it hasn’t even officially peaked yet.

The post Will Powell Pivot? Don’t Count On It appeared first on RIA.

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