The Fed Doesn’t Have What It Takes To Fight Inflation | Joseph Wang & Mish Shedlock

Episode Summary

Executive Summary: Joseph Wang and Mish Shedlock argue the U.S. is already in recessionary conditions even as inflation remains too high for the Fed to pivot easily. They expect higher-for-longer rates, structurally sticky inflation from housing, deglobalization and labor shortages, weaker stocks/bonds, and no near-term return to QE. Gold, cash, and select sectors like energy and healthcare are discussed as potential relative winners.

Main Topics: Recession signals vs. still-strong labor market (Priority: 5/5): Mish argues the economy is already in recession based on real final sales, retail weakness, housing collapse, and soft PMIs, while Joseph notes the Fed may still focus on low unemployment as a reason not to pivot. Fed reaction function and inflation priority (Priority: 5/5): Joseph says the Fed is prioritizing price stability over growth and believes officials see some unemployment increase as necessary to reduce inflation. He frames the Fed as likely to keep rates restrictive but not necessarily to extremes. Housing as the inflation and policy bottleneck (Priority: 5/5): Both speakers emphasize housing as the most interest-rate-sensitive part of the economy and a major Fed policy error in the past and present. Mish says falling housing prices may not quickly show up in CPI, while rent remains sticky. Higher-for-longer, but limited tightening capacity (Priority: 4/5): The discussion centers on whether Powell can hold rates high without triggering a sharper downturn. Joseph increasingly thinks the Fed may be too politically and culturally unwilling to sustain pain, leading to a smaller-than-expected terminal rate. Structural inflation forces and stagflation risk (Priority: 5/5): Mish highlights deglobalization, decarbonization, labor force retirements, wage pressure, and student loan relief as forces that could keep inflation elevated even amid weak growth, producing a stagflationary environment. Market outlook: stocks, bonds, gold, and cash (Priority: 4/5): The speakers argue markets are still pricing a soft landing or Goldilocks outcome that is unlikely. They expect weak long-duration assets, possible further downside in risk assets, and see cash, energy, healthcare, and potentially gold as more attractive. Policy tools beyond rates and QE (Priority: 3/5): Joseph notes the Fed can also use regulatory tools like counter-cyclical buffers and that Treasury buybacks could help market functioning, making a return to QE less likely unless rates first fall toward zero.

Key Arguments: Mish argues the economy already looks recessionary because housing, retail, PMIs, and real final sales have deteriorated even if employment remains strong. Joseph argues the Fed's main concern is inflation, not just growth, and that officials believe some labor market weakening may be needed to restore price stability. Both think the Fed is structurally constrained: low unemployment, sticky rents, and non-monetary inflation pressures make policy less effective than in prior cycles. Mish contends the current housing downturn is a direct result of Fed policy, especially mortgage-backed security purchases during a period of already-hot home prices. Joseph says the Fed is likely to try 'higher for longer,' but he increasingly doubts Powell has the resolve to sustain a very restrictive path if recession signals worsen. They agree that QE is unlikely to return soon; if balance-sheet expansion ever resumes, it would probably come only after rates are cut much closer to zero. Mish believes deglobalization, decarbonization, retirements, and pension stress support a period of weak growth and structurally higher inflation. Joseph thinks the market is underestimating how much a less aggressive Fed could still be hawkish, but he also acknowledges the futures market may be right about an earlier pivot.

Data Points: Unemployment rate: 3.5% - Used to argue the Fed is unusually worried about overtightening despite a very tight labor market. Inflation: 8.5% - Referenced as evidence that the Fed should still be hawkish. Fed funds rate: 2.5% - Current policy rate discussed as too low relative to inflation history. Stock market rally since mid-June: Apple up about 25% in two months - Cited as a risk-asset rebound the Fed may dislike if trying to tighten financial conditions. Housing prices: Down 15% in about six weeks - Joseph cites Zillow to illustrate a sharp housing correction. Housing sales: Down 29% year over year; down 38.5% since January - Mish uses this to argue the housing market is in severe contraction. PMI: 44 - Flash PMI reading cited as recessionary and below last month’s 47.5. PMI prior month: 47.5 - Used as the comparison point for the latest weak reading. CPI weighting: 31% rent and owner’s equivalent rent; plus 8% energy - Mish argues much of inflation is inelastic and difficult for rate hikes to affect. Federal Reserve hiking path: 3.25% to 4.0% possible - Discussed as the Fed's plausible 'higher for longer' endpoint. Treasury market level: Two-year yield back above 3.2% - Used to show rates markets still do not fully believe in a near-term pivot. MBS roll-off target: $35 billion per month maximum - Joseph explains the Fed’s mortgage balance-sheet runoff goal. MBS principal paydowns: About $25 billion per month - Joseph says this implies the Fed will fall short of its runoff target by around $10 billion monthly. Shortfall in MBS runoff: About $10 billion per month - The likely gap between targeted and actual Fed mortgage runoff. Boomers retiring: 22 million - Mish uses this to support a labor-supply and productivity inflation argument. Pension return assumptions: 8% expected annual growth - Mish says public pensions are vulnerable if markets only deliver low single-digit returns. Potential market return scenario: 2% stock market rises over the next five years - Mish says even this could leave pension plans in serious trouble.

Pivotal Quotes: "This is the Fed of Arthur Burns." — Joseph Wang: Joseph characterizes the Fed as timid and politically constrained despite high inflation. "When unemployment is 3.5%, inflation is 8.5%, Fed funds is 2.5% and you're worried about overtightening, this tells me that this is a very, very cowardly Fed." — Joseph Wang: Used to argue the Fed is underreacting to inflation. "I think a hard landing is baked in the cake, regardless." — Mish Shedlock: Mish says recessionary pressure is already building and policy will struggle to prevent a downturn.

Implications: Listeners should expect a prolonged period of weak growth, sticky inflation, and volatile risk assets. Near-term Fed hawkishness may persist, but a full pivot, QE, or rapid market recovery looks unlikely; selective defensive assets may outperform.