The recent rise in inflation might mean recession is already here

The recent rise in inflation might mean recession is already here.

In a post Friday, the team at Kessler Investment Advisors — a Denver-based firm specializing in US Treasurys — argued in a post that the increase in inflation we’ve seen means the economic cycle is already turning and recession is right around the corner.

The firm writes:

Counter-intuitively, the recent increases in core inflation are normal in the sequence of how a recession evolves
. The typical business-cycle sequence is that the manufacturing sector weakens first, then employment and consumer spending, and lastly, inflation. In fact, it is often not until the recession is over that inflation begins to come down. Inflation is the longest lagging indicator.

They include the following chart, which shows the spike in inflation right as each recession is getting underway.

(And we’d also note that recessions are retroactively declared by the National Bureau of Economic Research. So, for example, the 2008-09 recession that coincided with the financial crisis wasn’t declared until December 2008, though the economy had clearly been in the tank for months.)

Now, regular readers of BI: Markets know that I’ve very clearly been on the “no recession” side of the debate over the last few months.

And I continue to believe the US economy is not heading for recession.

Gas prices are low, consumer spending is robust, home prices are rising, employment trends are solid. The recent uptick in inflation, in my view, is the result of a tight labour market that has shifted the balance of power from capital to labour. I am willing to be wrong on this.

So we highlight the argument put forth by Kessler because while a number of commentators will lay out some version of a story that say…

  • Low oil prices will cause defaults among US shale companies…
  • …which will hamstring credit markets…
  • …which will tip the economy into recession.

…this argument is based on simpler business-cycle dynamics.

Essentially, the Kessler view here (as I understand it) is that traditional business cycle analysis tells you that manufacturing activity peaks, which is followed by a peak in employment, which is followed by a peak in inflation, which we realise only after-the-fact was the final sign the economy was heading into recession. Or rather, that the inflation uptick was the sign the recession was already here.

And if you think about what inflation really is — too much money chasing too few goods — then the idea that we’re only going to see enough money to push prices upwards fall into the hands of consumers after corporations who, from a labour standpoint, were long-time price makers become price takers, makes a lot of sense.

Which all goes to the broader idea that we’re seeing a peak in corporate profit margins, which while good on a micro level for US consumers and wage-earners is bad on a macro level for corporate earnings, corporate decision making, and the future of economic growth (even if the immediate impacts aren’t obviously negative).

Something to think about.

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