‘Something is going to break’ as rates climb, says TIS Group founder

Larry Jeddeloh says the Federal Reserve is approaching a point where its aggressive rate rises will “break” something in the US economy or global financial system.

Larry Jeddeloh, editor of The Institutional Strategist and founder of the TIS Group. Picture: Michele Mossop

The US Federal Reserve will lean into easing financial conditions after lower than expected October inflation by delivering a 75-basis-point rate rise next month, according to Larry Jeddeloh.

Inflation is cooling as reopening effects fade and pandemic-­related bottlenecks ease.

But the founder of influential Minneapolis-based The Institutional Strategist newsletter and institutional advisory service TIS Group sees US inflation staying well above the Fed’s target, as de-globalisation increases costs and the effects of the past year’s surge in energy prices flow through.

Jeddeloh thinks the US is already in a “modest recession”, which will be increasingly apparent in the first half of next year.

His comments came as Amazon founder Jeff Bezos warned that the US economy “does not look great” and that “if we’re not in a recession right now, we’re likely to be in one very soon”.

Mr Jeddeloh said the Fed was fast approaching a point where its aggressive rate rises would “break” something in the US economy or global financial system. When that happens, the Fed will put its rate rises on hold and potentially even resort to rate cuts or quantitative easing.

He said the Fed’s attempts to shrink its balance sheet by quantitative tightening this year had failed. He doubted the world’s most powerful central bank would be able to do much QT.

“I really don’t think they are able to do QT,” Mr Jeddeloh said.

“There’s just too much price risk (in bonds). The Fed has been talking QT, but they have done ­almost nothing. The reason is they simply don’t have the buyers for Treasuries. Nobody has ever done this before.”

It points to sustained volatility for equities as an economic growth slowdown and financial stability risks could be met by a shift in central bank policy to support both the system and the economy. It’s also an environment where bond investors will eventually demand greater compensation for inflation staying above 5 per cent.

Mr Jeddeloh still thinks US inflation can spike to double digits.

Despite recession risks, he sees crude oil prices supported by the Ukraine war, the OPEC+ cartel’s supply cuts and the increasing possibility of a new war in the Middle East that may involve Iran and Saudi Arabia.

Commodities remain attractive, with copper and uranium to benefit from decarbonisation, rare earths supported by US strategic demand and vast amounts of conventional energy needed.

This makes the Australian and UK sharemarkets relatively more attractive in his view.

Speaking to The Australian at the UBS Australasia conference in Sydney, Mr Jeddeloh said that while the sharemarket had been relieved by signs that US inflation was retreating from multi-decade highs, the inflation rate was likely to bottom three or four percentage points above the Fed’s 2 per cent target.

“We think (US CPI downside potential) is 5 or 6 per cent,” he said. “There is embedded inflation now coming in higher energy prices and higher wages coming.

“We haven’t seen the peak in energy prices in my view.”

In that environment, he does not see the Fed slowing the pace of rate rises just yet.

“The most hawkish Fed since (former FOMC chair Paul) Volker” now has a “window to do another big rate hike in December” before slowing to 50-basis-point increases in the first quarter.

But on top of the sharp falls in US housing market activity, government bonds and cryptocurrencies this year, “something is going to break” and then “QT and rate hikes are off the table”.

Case Shiller’s inflation-adjusted US house price index has come off a peak about 15 per cent above the previous major peak achieved in 2006 before the subprime crisis. “I think if it’s bad enough, (the Fed) will have to reverse,” Mr Jeddeloh said.

While the Fed might simply stop lifting rates prematurely, he said the Fed could cut rates much sooner than forecast in the event of a crash in the US housing or sharemarkets.

But Mr Jeddeloh expressed some doubt about the Biden ­administration’s sensitivity to ­potential Wall Street sell-offs, compared with that seen during some past administrations.

He also doesn’t see the Fed ­resorting to large-scale QE “unless they’re forced to”.

“A lot of the inflation goes back to an extended ­period of free money,” he said. “It took 10 years to get here … why are we going to get out of it in 12 months?”

Despite potentially deflationary effects stemming from China’s currency depreciation, he predicted that US costs would continue to rise amid a “removal of US supply chains from China”.

He predicts 60-70 per cent of the US supply chain will move to the US in the next decade.

“It’s a national security issue,” he said. “The US is going to relocate as much as we can.”

The $US20bn ($31bn) “mega-site” for advanced chips, spanning 405ha, which is being built for Intel in Ohio is just one example.

“We’re building chip makers all over the country,” he said.

Apart from chips, he predicts a reshoring of batteries, pharma, ­renewable energy and rare earths production capability.

“There’s no way we can produce any of those things as cheaply in the US as the Chinese have, so costs are going to go up.”