Ghosts of Growth
Winter, with its frosty breath and warm hearths, is the season I cherish most for rekindling old friendships. As I wander the snow-covered streets or sit by the crackling fire, a curious thought often stirs within me: "What fate or fortune has befallen my dear chum in the past year?"
And so, as the days grew shorter, I invited my cherished friend, let’s call him Ebin, to join me at the tavern to catch up on the latest economic and market scuttlebutt and raise a glass to 2025. “The S&P 500 hit new highs, again,” I said. Ever the cantankerous sort, Ebin let out a deep “bah humbug!”1 before admitting that he’d gotten out over the summer. “The economy is in a truly terrible state! Leading indicators have been negative for how many months? The yield curve is still inverted. The Fed’s in no hurry to provide relief, and the Sahm rule triggered a few months ago. Who knows what the new administration will do? A recession is coming, my friend, no doubt about it.”
After parting ways, Ebin hurried home, closed his door and locked himself in; double-locked himself in, which was not his custom. As he got ready for bed, he heard a booming sound coming from the direction of his wine fridge. He scurried to the location, only to find broken bottles and a dark figure.
“There are only three ways a smart person can go broke: liquor, ladies, and leverage,” the figure said.
“How now,” said Ebin, “who are you?”
“In life, they called me Munger.”
“In life? Munger?” Ebin questioned, before it dawned on him that this was the ghost of Charlie Munger. Cowering on the floor, he cried out, “And what do you want from me?”
“Tomorrow isn’t promised but tonight, you will be haunted by three spirits,” the shape ominously croaked before fading into the ether.
Wondering what must have been in his drink, Ebin went straight to bed without undressing and fell asleep upon the instant.
After a short, fitful sleep, Ebin awoke in a cold sweat, Munger’s ominous warning echoing in his mind. As his eyes adjusted to the dim light, he discerned a peculiar figure standing in his room — a tall, bald man chomping a cigar.
“Who, and what, are you?” Ebin demanded.
“I am the Ghost of Inflation Past.”
Ebin was incredulous but bolted to attention. “Inflation spiked in the post-COVID period due to supply chain disruption, fiscal stimulus, and — though I am loath to admit it — accommodation from central banks. But central bank rate hikes have helped bring inflation under control,” the ghost proclaimed.
“Yes, I understand that, but why can’t the Fed cut more aggressively now that inflation is back down?”
“Central banks need to restore their inflation fighting credibility. The Fed’s September Summary of Economic Projections forecast core PCE inflation to be 2.2% in 2025, so inflation is down but not back under control. While the Fed’s inflation objective is expressed in terms of headline PCE, alternative indicators can help provide insight into where inflation will go in the future.”
The ghost produced a tattered scroll (Figure 1) showing Ebin the Atlanta Fed’s calculation of Sticky and Flexible inflation. “The sticky components, particularly housing, remain elevated and could keep inflation strong into next year as they take longer to moderate,” the ghost proclaimed.
Figure 1: Flexible Inflation Falls Below 0%, but Sticky Inflation Slow to Return to 2%
Pulling out another worn parchment (Figure 2), the ghost concluded, “thus, current futures market pricing is for a slow and gradual pace of rate cuts into 2025, consistent with recent comments from Chair Powell.”
Figure 2: Fed Likely to Cut at December Meeting, But Only 3 Cuts Priced in 2025
With all this talk of inflation and monetary policy, Ebin found himself overcome by exhaustion and drowsiness2, eventually succumbing to a heavy slumber.
Yet the respite was short-lived, and Ebin soon found himself pacing his apartment in the dead of the night, checking every door and window to make sure he was truly alone. Returning to the bedroom, he beheld a throne fashioned from a lifetime's worth of take-out containers, heaped haphazardly upon the floor. Upon that throne sat a jolly giant.
“Good thing I was wrong about food production increasing linearly!” the giant figure mused to itself.
Ebin took in the scene with a confused expression.
Noticing his befuddled face, the giant spirit offered an introduction: “I am the Ghost of Coincident Indicators,” it proclaimed. “Look upon me.” And Ebin duly complied.
The spirit continued: “US GDP rose at a pace of around 3% (QoQ annualized) over the past two quarters, above the post-Global Financial Crisis (GFC) average. The economy is in good shape. Other coincident indicators that the NBER uses to identify recessions, like personal income excluding transfer payments, job growth, and manufacturing and trade sales are growing at a solid pace.”
“You left out industrial production,” Ebin replied wryly.
The figure responded, “Well, the economy can’t be perfect, can it?”
“And what about leading indicators?” Ebin asked.
The ghost acknowledged, “Yes, leading indicators are quite bad, but they are driven to a large extent by the inverted yield curve. An inverted yield curve, particularly at the short end, is historically a good proxy for when monetary policy is expected to get tighter, and tighter monetary policy tends to occur before a recession. However, we are coming off a period where the economy was running hot, so some amount of Fed tightening was appropriate to prevent overheating and hopefully engineer a soft landing.”
“And the Sahm rule violation, should we just ignore that?” Ebin followed up.
“Well… Claudia Sahm herself has expressed some skepticism about the recent signal. It’s true that unemployment has climbed higher, and it is always wise to keep a close eye on these indicators, especially when they suggest that downside risks are increasing – as is the case now. But as with leading indicators, we are emerging from a period with an overheated labor market. Job openings still exceed the number of unemployed individuals, a contrast to the post-GFC period. Seasonal factors have also disrupted recent labor data. If you isolate the cyclical components of unemployment,3 they remain below the historical average, although admittedly, we have seen a modest upward trend here as well.” The ghost then pointed to Figure 3 and said, “When the US entered recessions past, unemployment claims data spiked higher, and we haven’t seen that yet.”
Figure 3: Initial Unemployment Claims Remain Near Historical Lows
After considering the figure, Ebin turned toward the spirit, prepared to counter that claims are typically a lagging indicator, but the ghost was gone. Lifting up his eyes, Ebin beheld a solemn phantom, draped and hooded, approaching like a mist along the ground.
The phantom was silent, but his countenance suggested it had said, “in the long run we are all dead” one too many times during its life. And Ebin knew that he was in the presence of the Ghost of Policy Yet to Come.
Gathering his wits, Ebin boldly asked, “I know stock markets have rallied in anticipation of favorable economic stewardship during President-elect Trump’s second term, but what about tariffs, what about geopolitical uncertainty, what about fiscal deficits?” The spirit dug through its robe pockets, retrieved a magic eight ball, gave it a shake, and pointed to the answer. Ebin read, “ask again later.” The ghost bestowed upon Ebin a tome, directing him to study the past, and dissipated into a smart phone.
Recognizing the phone as his own, Ebin felt a surge of enthusiasm. “You’re right,” he typed out, reflecting on how the evening began. “The US economy may just be in better shape than I had thought,” and clicked send. But in his sober-minded heart of hearts, he felt he was right to be concerned about downside risks, and followed up with, “But there’s still a bit of humbug!”
1Yes, it’s another retelling of “A Christmas Carol”. And no, there is no Ebin, only Ebenezer (Scrooge, that is).
2As do most of this author’s friends and relatives. Particularly when I break out the charts and graphs!
3Measured by the rate of job losers not on temporary layoff as a percent of the labor force.
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