Immanentizing the Inflation Eschaton
“Don’t let them immanentize the eschaton” was an improbably popular slogan among conservatives of the 1960s and ’70s. It now looks like a good maxim for considering inflation and interest rates.
For several months, many Wall Street analysts, financial media pundits, and prominent economists have been enamored with the idea that inflation would fade quickly and immaculately, meaning without a significant downturn in the economy. The deft management of the economy by the Fed was bringing about the heavenly state of lower inflation, lower interest rates, and low employment, according to the Immacultists.
The eschaton slogan became a motto of the Young Americans for Freedom, appearing on bumper stickers and lapel buttons put out by the group, after being popularized by National Review editor William F. Buckley, Jr. It was Buckley’s summary of a point made by political scientist Eric Voegelin. In his book The New Science of Politics, Voegelin had argued that a number of modern political theories were descended from the older gnostic view that the disorder of the world can be transcended by extraordinary insight, learning, or knowledge.
In the context of contemporary economics and financial markets, this idea came to be known as the “soft landing” thesis, often coupled with the telling phrase “immaculate disinflation.” The extraordinary insight of the Fed could bring about an end to post-pandemic inflation and a return to the pre-pandemic situation of moderate price increases coupled with low employment. As Belinda Carlyle once instructed us, “Ooh, baby, do you know what that’s worth? Ooh, Heaven is a place on Earth.”
Many were so convinced that inflation had already been conquered that they became convinced that the Fed had already “over-tightened” and would—or at least should—immediately disavow further hikes, begin signaling cuts were coming, and then cut rates early next year. The view that the Fed would cut rates next year became so solidified that the odds of at least one cut rose to 96 percent, according to the CME’s Fedwatch tool.
The Bond Market’s Rout
Lately, however, financial markets have not been cooperating with this view. The yield on ten-year Treasuries has risen from 3.287 percent at its recent low back in April to 4.697 percent on Friday. The yield has risen by around 70 basis points—a basis point is one hundredth of a percentage point—since the end of August. It’s up 50 basis points since the Federal Reserve announced that it would hold its rate target steady in September while signaling uncertainty about whether it would hike again at one of the two remaining meetings this year.
Many analysts were perplexed by this movement in bond yields because it did not match up with the narrative informing their forecasts. An increasingly prevailing view was that the Fed had made a mistake by overtightening and insisting that it would keep rates high next year, and this was pushing bond yields up to levels likely to trigger a recession next year. The Fed, in other words, had failed to genuflect before the holy immaculate disinflation that would happen with lower rates and was therefore standing in the way of the economic eschaton.
Fascinatingly, even though the Fed flipped from hero to villain and the expectations for next year from soft-landing to hard-landing, the outcome interest rate remained the same: the Fed would cut rates next year. Indeed, the CME Fedwatch tool shows the same chance of easing by the end of next year that it did a month ago, before the most recent run-up in long term rates.
The Book of Jobs and the Power of Prophecy
The September jobs report released Friday should cast further doubt on the probability of the soft-landing outcome. The economy added 336,000 workers to payrolls in September, around twice as many as Wall Street was projecting. What’s more, revisions to the two prior months added another 119,000 jobs to employment. These revisions demonstrate that September’s figure was not an outlier but the beginning of a trend toward higher levels of employment.
It now looks like June’s low of 105,000 was the outlier rather than the beginning of a trend toward softer jobs numbers. The figures also show that Wall Street’s analysts continue to underestimate the strength of the labor market—and because of that, continue to underestimate the persistence of inflation and higher rates.
Not everyone is convinced. As many analysts dismissed the huge upside surprise in job openings earlier this week, there were plenty willing to downplay the importance of the September figures and revisions earlier this month. “Probably just a blip in a gradual downward trend, though always worth considering the possibility of stabilization,” said Guy Berger, Principal Economist and Head of Macroeconomics at LinkedIn.
Jobs chart thread!
1/ First off, a very strong establishment survey. NFP was the strongest (+336K) since January, and robust upward revisions (+119K).
Probably just a blip in a gradual downward trend, though always worth considering the possibility of stabilization. pic.twitter.com/cWwTJXZlXk
— Guy Berger (@EconBerger) October 6, 2023
“We always want to avoid reading too much into any one month, and in this regard, this stronger-than-expected report does not reverse the conventional take that the job market has been cooling in recent months,” the White House’s Council of Economic Advisors said on Friday.
Jim Bianco of Bianco Research pointed out on X that many Wall Street analysts seem to reject the idea that we might be in a higher inflation era that is very different from what we faced pre-pandemic.
Wall Street keeps thinking nothing of lasting significance happened in the spring of 2020, so they keep pounding away with all the same pre-pandemic rules and then “struggle to explain” when none of these rules work anymore?
In other words, don’t be @Austan_Goolsbee. He is…
— Jim Bianco (@biancoresearch) October 5, 2023
Bianco has a very good list of explaining these numbers. We could also add that war is inflationary, the influx of new consumers coming across the southern border and taking relatively low productivity work is inflation, and the green-energy transition is inflationary. What’s more, the recent experience of high inflation demonstrates that inflation is much less a thing of the past than many had thought pre-pandemic. Those assuming the prevailing economic conditions should adjust their assumptions about inflation because they have been proven inadequate.
Yields Are Rising, So Should the Fed’s Target
Bianco has argued that one reason longer maturity bond yields are rising is likely that the Fed appears to have signaled it is not serious about fighting inflation, so the market is pricing in higher inflation and therefore higher yields to compensate. A related interpretation is that the market sees growth itself will be higher next year than previously thought—as suggested by the surge in hiring and job openings—and therefore that the Fed will just not have a reason to cut next year.
Harvard’s Jason Furman on Friday argued that the market was over-anticipating a rate hike at the next meeting after the jobs report came out.
I’m just not seeing the 29% chance of a rate hike at the Nov meeting.
GDP won’t really be news, would be very surprised by a 0.3%+ core CPI print for Sep (and even that shouldn’t be enough), this report suggests moderate ECI but regardless one data point shouldn’t move them. pic.twitter.com/oVlS3r6VTH
— Jason Furman (@jasonfurman) October 6, 2023
Our reading is exactly the opposite: the market is under-anticipating the odds of a Fed hike. When the Fed last met, it was looking at data that showed a downward trend in employment. The June and July jobs numbers had been revised down a total of 110,000 jobs. The three-month average of job gains had fallen to 150,000. Unemployment had ticked up to 3.8 percent.
When it next meets, the Fed will be looking at upward revisions to the July and August figures. The three-month average of jobs gains has jumped to 266,000. Unemployment is not rising any further. The newly revived GDP nowcast of the New York Fed shows the economy growing 2.5 percent in the third quarter, up from 2.25 percent when the Fed last met (and the Atlanta Fed’s nowcast remains at the extraordinarily high 4.9 percent).
If the Fed is data dependent, as it has often said, it should move its rate target up now that data suggests a much more resilient economy. At the very least, it should end the year where the Summary of Economic Projections have pointed since June—around 5.6 percent—which would mean one more rate hike.
The Fed, of course, may decide to take Furman’s view, which would mean largely returning to the Immacult, so predicting the Fed’s next move is largely a fool’s errand. As Professor Voegelin taught us, “the course of history extends into the unknown future.”
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