Why The Economy Might Be More Fragile Than You Think

When the CPI data hit last week, markets took it as a positive sign. And why not? Inflation was flat in October and the market got to thinking that the 'soft landing' had been achieved.

But that might not be the case. Broader macroeconomic factors indicate that the instability is deeper and more lasting.

Here are five reasons why the economy might be more fragile than you think.

‘Higher For Longer’ Interest Rates

Following the pandemic, the Federal Reserve employed quantitative tightening policies, in an attempt to rein in inflation after a massive splurge of spending under Covid. 

Since then, the Federal Reserve has maintained the high interest rate levels and continues to uphold its hawkish stance. It's also expected to keep them unchanged until May of next year and has signaled fewer reductions than previously suggested.

The Federal Reserve's forward-looking projections are outlined in the traditional dot plot featured in its reports. Despite the Fed's intentions to implement additional interest rate hikes, based on the latest data, the market remains unconvinced of this possibility.

This skepticism is apparent in the implied futures rates compiled by the Chicago Mercantile Exchange (CME), as the market is 100% sure that the FED won’t do what they said they would in September.

Keeping rates high to prevent inflation from spiraling out of control is mandatory according to FED objectives. However, if rates remain high for too long, it could impede the flow of lending, potentially causing overleveraged businesses and homeowners to suffer.

Persistent Inflation

The increase in prices is self-explanatory. We've discussed this particular issue extensively; inflation data can be altered to 'hide' uncomfortable truths. 

For instance, if we were to use the methodology from 1980, inflation in 2022 would show an annual peak of 17% and would be currently hovering around 10%, according to Shadowstats.

Another indication of the persistence of inflation lies in the evolution of the price increases taking place. Presently, we’re witnessing notable surges in the primary goods and commodities markets, which represent the initial links in production chains. To illustrate, prices for items such as cattle or sugar have risen by approximately 40% throughout 2023.

In this case, there is a cost-push effect throughout the production chains, impacting producers first, and eventually, consumers.

Naturally, the Consumer Price Index (CPI) fails to capture the cost-push effect throughout the chain. When we look at the Producer Price Index (PPI), we can clearly see that there has been an increase of nearly 39% since 2020. This indicates that there is still a significant portion of the increases that have not been passed on to the public and are still "pending."

The enthusiasm regarding a 4% core inflation in the last year should be tempered with consideration of the reality that things might be worse than they look. For instance, the United States has utilized almost half of its strategic oil reserves in the last year to maintain gasoline prices at acceptable levels, a potentially unsustainable policy.

A lot is being done to maintain the appearance of stability - and not just in regard to the currency.

Inflated markets

Speaking of uncomfortable truths, here’s another one: the current state of the U.S. market is driven more by monetary policy rather than economic performance. 

From the looks of it, the market seems to react more to the Federal Reserve's announcements than it does to earnings reports. The market, as a whole, has become overly focused on anticipating the next monetary policy decision rather than real economic growth.

Moreover, the major performance metrics, such as the price-to-earnings ratio or the Buffett Indicator, indicate that prices are currently in the "overvaluation" zone—an aspect we've covered in previous articles.

Government Debt - The Elephant In The Room

So far, we've explored aspects related to monetary policy and the private sector. But what about the Treasury? As you've likely seen in the news, the debt ceiling has become a hot-button issue once again.

Largely due to high interest rates, the U.S. is accumulating debt at its fastest pace ever, which presents the country with another difficult choice. Increasing interest rates helps curb inflation, yet the cost of servicing debt in terms of GDP is the highest in 30 years. The higher the rates, the higher the debt service - but without high rates, inflation could go completely off the rails.

How will the United States approach this challenge? One solution could be budget responsibility - but we’re not going to hold our breath. 

Hegemony Under Strain

The final point to consider revolves around the relative decline of power of the United States on the global geopolitical stage. The emergence of China, Russia, and their spheres of influence—like the BRICS+ nations (Brazil, Russia, India, China, South Africa, and now, Argentina)—marks a new chapter where the world is undergoing political and economic fragmentation.

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There’s no doubt that the U.S. is still a hegemonic power - but its dominance is undeniably less extensive than it was. The country is now attempting to redefine its sphere of political and economic influence, with NATO as its military arm and the European Union, Canada, and Mexico as its key economic allies.

This leads us to a major rising tendency: nearshoring, a strategy employed by the U.S. and others to diminish reliance on China and reduce potential disruptions in supply chains. It involves relocating the production of goods and services to countries that share greater affinity with the United States and the Western order.

The economic impact of nearshoring is twofold. On one hand, it decreases costs for American companies by relocating production to lower-cost environments. Simultaneously, it revitalizes countries that the United States considers allies, pumping dollars into the economy and creating industry. 

Conclusion

To hear the powers that be tell it, the ‘soft landing’ scenario will play out and we’ll all live happily ever after. But those of us that are actually paying attention know full well that these rosy forecasts won’t come to pass. Too many signs are pointing to instability, and the Fed and others have been kicking the can down the road for too long.

If you want to protect your wealth against this instability, no matter how it may manifest itself in the future, you want to own farmland. Farmland is one of the most secure asset classes in downturn cycles and can help you achieve a truly diversified portfolio.

Get in touch with our team to learn how you can own farmland today.

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