21st Century Business Herald reporter Xiang Xiufang New York reported that in the first half of this year, the US GDP grew negatively for two consecutive quarters and fell into a technical recession. U.S. CPI edged back to 8.5 percent in July, with inflation starting to show signs of slowing, but non-farm payrolls figures of more than 500,000 suggest the labor market remains overheated.
Amid different signals from economic data, U.S. stocks rebounded sharply after hitting a year's low in June. The S&P 500 has been up 11% since June 16. Is this a brief rally in a bear market or the beginning of a new bull market? Market investors struggled for a time. Until the recent annual meeting of the Jackson Hole central bank, Fed Chairman Powell issued the strongest "hawkish" voice, completely extinguishing market expectations about "policy shifts", and investors began to increase their bets on the downward trend of the stock market.
Previously, on August 18, the reporter of the "21st Century Business Herald" of the Southern Finance and Economics All-Media Group exclusively interviewed Wu Hao, a senior researcher at the New York branch of the Industrial and Commercial Bank of China. He believes that the probability of INFLATION in the United States has peaked in the short term, but it has shown a central upward trend in the medium and long term. In order to curb inflation, the Fed will continue to remain hawkish, and even if there is a recession in 2023, it is unlikely to cut interest rates. He doesn't think the rally means the U.S. stock market has safely emerged from the bear market. In the current environment, the Fed's "put options" have not worked, and avoiding triggering a credit crisis is the bottom line of the Fed's tightening policy.
Inflation is likely to peak in the short term
21st Century: The US CPI fell slightly in July, and inflation peaked became a hot topic in the market, do you think US inflation has peaked?
Wu Hao: I tend to distinguish between medium- and long-term and short-term. In the long run, unlike the relatively stable overall inflation and the continuous decline in interest rate centers in the three or four decades since the Volcker period in the 1980s, the next few decades may show a trend of high upward pressure on inflation and rising fluctuations in interest rate centers. It is mainly affected by a number of factors, including the shift of the industrial chain from efficiency priority to security priority in the context of de-globalization, the return of the industrial chain or the cost increase caused by the transfer and restructuring of onshoring or nearshoring. In response to global climate change, the shift from traditional to clean energy will also lead to some increase in costs. In addition, the structure of the labor force, the decline in the global birth rate, the politicization of immigration, and the aging of the population are the main structural factors that drive up inflation.
In the medium term, for example, in two or three years, the path and eventual level of inflation decline depends on the resilience of the US economy and the Determination of the Federal Reserve to control inflation. This is a game process, not static. In 2020, the Fed adopted an "average inflation target" after reforming its monetary policy framework. So, a little above the 2 percent level for a while, say around 3 percent, may be acceptable to the Fed, but they may have limited tolerance for higher levels of inflation, say, more than 4 percent. Ultimately, how determined and fast will the Fed be to get back to its target level? Would that have changed if there had been a recession? This will be a dynamic judgment process.
In the short term, inflation is likely to peak, but after entering the downward channel, it may not be a rapid downward trend, but there will be greater volatility, and there is also uncertainty about the level of inflation from the second half of this year to the first half of next year. For now, whether inflation has peaked will take at least a month or two to confirm, and the Fed may also have this time consideration. The factors that guide inflation downward in the short term are the so-called Bullwhip Effect (bullwhip Effect, the distorted excess of some commodity inventories in the previous period led to the downward pressure on commodity consumer prices) and the high base effect (commodity prices rose sharply in the summer of 2021 year-on-year, and the percentage increase in prices such as commodity energy has been relatively narrow in the short term).
On the other hand, the factors that may lead to inflation continuing to rise are service consumption and living costs, which are relatively lagging behind in the previous period, but there is still upward momentum and room for prices. The proportion of living costs in the CPI and the core CPI reached 30 and 40% respectively, according to the survey of housing intermediaries, high interest rates are suppressing residential real estate prices while forcing potential buyers back into the rental market, and August is still the peak month for renting, so although the stabilization of real estate prices or even the decline is a general trend, the overall trend of living costs needs some data to be further confirmed.
In addition, a big difference from the high inflation environment of the 1970s is that inflation expectations are not out of control, so the Fed is particularly concerned about whether the wage price spiral can be formed, and is also paying close attention to when the upward trend of the labor cost indicator ECI will turn back.
The labor market is strong but unbalanced
21st Century: While the economy entered a technical recession, new non-farm payrolls in July far exceeded expectations, and labor markets remained tight, with Fed and Treasury officials stressing that there was no substantial recession. How to interpret the state of the labor market?
Wu Hao: Recently, there is a saying that the economic recovery after the 2008 financial crisis is an "unemployment-type recovery", because the unemployment rate has been at a high level for a long time in the process of economic recovery, and it is said that the current economic recovery is an "employment-type recession". But leaving aside the political factors in defining a recession, such a strong labor market and resilient consumption suggest that the current fundamentals of the economy are difficult to describe as a substantial recession.
At present, the labor market is very strong, if you look at the overall number of jobs, look at the unemployment rate, look at the wage growth rate, it is really strong, but it is not a monolithic, the industry is very different, highlighting the imbalance in economic development between the plates. For example, the technology industry, including Meta, Netflix and other technology giants have begun to lay off employees or freeze recruitment. The number of new jobs in the financial sector is decreasing. In the transportation and warehousing, leisure tourism and hotels, and health care and social assistance sectors, the new jobs created last month were in the 100,000 level. In terms of employment, the employment population of the low-end service industry is much larger than that of the technology industry. So overall, the economic recovery under the impact of the epidemic is not synchronized and unbalanced, and some industries do feel that winter is coming.
More than 500,000 new non-farm payrolls were added in July, an exceptional number that would be exaggerated. It is likely to fall back. So, after falling back to more than 200,000, that is, the pre-epidemic level in 2018 and 2019, can it be maintained for a period of time? I think it's possible. It can be said that the current labor market is overheated and needs to be cooled, but it is difficult to say that the labor market is weak, and there is still a long way to go from weakness. This is also why the Fed attaches great importance to employment factors when making policy judgments. If the jobs data pulls back, it may be less worried about a long-term stickiness in inflation.
The consumer market is generally stable
21st Century: Retail sales data for July was flat month-on-month and fell short of market expectations. Under the influence of high inflation and rising interest rates, what is the momentum of US consumption?
Wu Hao: For the Retail Sales data in July, the market's immediate response was relatively mild. Some people see the good side, and some people see the bad side. I think the data is actually relatively bland, not good enough or bad enough to let the market turn and change investors' "beliefs".
The trend in the consumer market itself is shifting from goods to services, which is a structural shift. Although the proportion of retail sales of goods in the economy is relatively high, it is understandable that the chain does not increase, but on the contrary, if the retail sales data is very strong, it will make people very suspicious, because everyone is turning to service consumption, and there is still a strong retail sales data, which will make people feel that the economy is still very overheated. In terms of July's specific data, it is mainly gasoline and automobile sales that are falling, but the data is not surprising overall, from the expected growth of 0.1% to 0, the difference is not much.
Judging the resilience of consumption mainly depends on two aspects, one is the wealth effect and the other is the income effect. In terms of wealth effect, one is the price of real estate and the other is the price of the stock market. Taking the stock market as an example, the S&P 500 index now exceeds 4,000 points, much higher than the 3,300 points in February 2020 before the epidemic. Even going back to the bottom of around 3700 points in mid-June this year is much higher than the original. The other is the real estate price, although the speed is now cooling down or even the price is falling, but it has regional problems. That is to say, the resident wealth effect can still play a role for a period of time.
Bill Dudley, former President of the New York Fed, has said that inflation is not going to go down if the stock market is good and the wealth effect is strong. In other words, tighter financial conditions (stock market declines) are the effect the Fed wants to see. Because the Fed cannot change the supply side, it must suppress the demand side, and if there is no reverse wealth effect, the Fed's suppression of demand may be reduced.
In terms of income effect, residents' real wage incomes have been eroded by inflation. But for Americans, as long as they work, they are less sensitive to the matter of leveraged consumption. So the key is, what is the leverage ratio of residents? Is the resident's balance sheet healthy enough? If you look at the data, the overall health is relatively healthy. As long as the labor market is still stable, this income effect will continue, and there is still room for leverage in the residential sector, such as the use of credit cards.
Even a recession will not cut interest rates next year
21st Century: Has the Fed's Monetary Tightening Policy Had an Impact on the Real Economy? How to predict the Fed's follow-up policy path?
Wu Hao: The Fed's tightening of monetary policy has had an impact. Interest rate-sensitive sectors such as real estate and auto loans are directly affected. But there are many more implications to come, and the effects of monetary policy are generally lagging behind. I judge that the rate hike in the second half of the year is unlikely to stop, but the pace will gradually slow down.
Now the market is arguing about whether to add 75 basis points or 50 basis points in September, and I think the difference between 25 basis points is not large, and the market mainly wants to read more signal nature things from the Fed's rate hike rhythm. However, the slowdown in the pace of interest rate hikes in the second half of the year is relatively certain. Because we have seen the policy work, but we still have to wait for the effect of monetary policy to further appear. However, some market views that the Fed will cut interest rates in 2023, I strongly disagree, I tend to think that even if there is a recession in 2023, the Fed is unlikely to cut interest rates.
On the one hand, if the Fed really learned from the mistakes of monetary policy in the 1970s, it must not take a stop and go approach. Inflation expectations must be stabilized very firmly in order to control inflation, or inflation will become stubborn. In the 1970s, the Federal Reserve cut interest rates in response to a recession, but then found that the recession was short-lived, and inflation immediately went up again. If the policy stops and goes, it will not solve the problem.
On the other hand, in addition to judging what the Fed should do, it is also necessary to judge what Powell will choose to do, that is, how Fed policymakers will make decisions. I think Powell has been relatively market-friendly in the last few years, but I think he is still very determined in following Volcker's control of inflation. If he "turns the dove" sharply, the market surge will affect the achievement of the Fed's policy objectives. It's really a game between the Fed and the market.
Now that the Fed is not behind the market or the curve, is it coming at its own pace or following the market? Historically, the probability is completely fifty-fifty-to-five. From the observations of the past decade or so, sometimes the Fed is right, and sometimes the market is right. It is by no means the Fed that must "surrender" to the market. Again, don't fight the Fed.
The real estate market is de-bubbleging
21st Century: With the Federal Reserve continuing to raise interest rates aggressively, mortgage rates soaring, and the affordability of U.S. home buyers near historic lows, many analysts have expressed concerns about the housing market.
Wu Hao: First of all, the real estate market is de-bubbled, and there is no ambiguity about this. The focus now is on how different it is from the 2008 crisis. I think the biggest difference is that the standard of bank lending has not been lowered, the balance sheet of residents is generally stable, and if there is no huge recession in the labor market, there should be no wave of abandonment and sell-off like in 2008. In addition, the capital reserve ratio of the banking industry is still very sufficient, even if there is a certain degree of loss, the bank can bear it. Therefore, there is a high probability that there will be no crisis like in 2008.
As for the market prospects, in fact, it is more differentiated, and the real estate market in some parts of the United States has stronger financial attributes and greater risks. However, in some areas, especially in suburban school districts, demand is still very solid, and the solvency of home buyers is also relatively solid. In the real estate market in some parts of the Bay Area, the financial attributes are relatively strong, and the house prices have risen sharply and fallen.
The return of U.S. stocks to a bull market is not what the Fed expects
21st Century: What are the reasons for the big rebound in US stocks since mid-June? Does it mean that the US stock market has come out of the bear market?
Wu Hao: First, the phase of "killing valuation" is over, and the forward price-earnings ratio of the S&P 500 index has returned to about 15.5 times at the low point of June, which is probably near the historical average and has been lower than the average of the past 10 years. For some investors, in the absence of a recession, the 15.5 times forward price-earnings ratio has been more reasonable, and some well-known value investors have begun to read the bottom, such as Buffett in the first quarter in the "bottom", Oak Capital's Howard in the second quarter in the "bottom". It can be seen that from the perspective of value investors, reasonable PE is a very important signal.
Second, the market began to bet that U.S. inflation had peaked, believing that the Fed's monetary policy had the opportunity to pivot and even price a price in next year's Fed rate cuts. Of course, the Fed pivot does not necessarily point to a shift in direction, and slowing down the pace is also seen as the beginning of a turn. I don't think this rally means that U.S. stocks have safely emerged from the bear market.
From a policy point of view, if the US stock market enters a big bull market, the financial situation will further relax significantly, which is not what the Fed expects. The Fed has not fallen behind the market, and follow-up policies will not necessarily follow the market. I think the Fed will remain hawkish verbally.
From the perspective of fundamentals or corporate earnings, the profits of US listed companies may fluctuate sharply, and corporate differentiation will be more obvious. For companies with huge moats, the current 3% borrowing financing costs, 8% inflation rate may bring 8% revenue growth, profits do not necessarily have to be reduced. It is true that many companies in many sectors have not yet lowered their revenue expectations, or even raised their revenue expectations. For good businesses, it has the ability to transmit the rise in costs to consumers. Profits will not be squeezed by inflation and performance will not be as bad as expected.
But interest-rate-sensitive businesses have difficulty refinancing. At the end of last year, the russell 3000 index counted the proportion of zombie companies as about 30%. Zombie companies are thinly profitable and sensitive to rising debt costs, and refinancing in a high-interest-rate environment can be difficult. So, when debt levels are high, how high will interest rates cause them to have a credit crisis and make zombie businesses go bankrupt? From 2008 to the present, including during the 2020 pandemic, the United States has hardly seen a wave of mass bankruptcies. From 2008 to now, there has been no large-scale credit crisis for 14 years. In fact, there is a liquidity crisis in 2020, but because of the FINANCIAL BAIL case of the US government, the government directly injected capital into the balance sheet of the enterprise, so that the enterprise did not have a large-scale credit problem, so that the enterprise eased up. Now, without the support of macro policies, can zombie companies continue to survive?
I think that in this cycle of interest rate hikes, it is only when the Fed sees that some companies are starting to go bankrupt and the credit risk to the financial system has risen significantly, and it may really consider switching to rate cuts. It won't worry too much about the stock market during this cycle. That said, Fed "puts" are likely to be ineffective in the current environment. It is unlikely that asset prices will ease policy as soon as they fall, and this is not its bottom line. The Fed has even made it clear that a moderate recession is acceptable. As long as there is no large-scale bankruptcy, no large financial institutions or enterprises failing, it will not change direction, this is its bottom line.
In addition, about 30% of S&P 500's revenue comes from overseas, including exposure to European markets as well as to emerging markets. This means that even with the U.S. market itself healthy, about 30% of revenue is likely to be flat or worse, because Europe and emerging markets are not in a good situation right now, and the probability of a recession is still much greater than that of the United States. Overall, zombie companies are an important risk point, and overseas market profits are also a risk point. It is expected that the US stock market will continue to find its way in the midst of large fluctuations, and the differentiation of individual stocks will continue.
(This article only represents the personal views of the interviewees, does not represent the views of ICBC institutions, and does not constitute investment advice.) ）
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