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Guest Contributor: The Fed’s Impending Inflation Disaster? (Part 2)

by Dr. Daniel ThorntonD.L. Thornton Economics


Guest Contributor: The Fed’s Impending Inflation Disaster? (Part 2) - Inflation cartoon 07.22.2014


I have had a couple of responses to my impending-inflation-disaster essay suggesting that I’m the “boy who cried wolf.” They note that I (here) and others have been concerned about the potential inflation effects of the Fed’s QE policy for some time. But there’s been little smoke and no fire.


I am aware of the fact that the empirical relationship between money and inflation has been essentially nonexistent since the early 1980s. Indeed, early last year I argued (here) that neither the Phillips curve theory nor the monetary theory of inflation has credible empirical support.

Nevertheless, I am inclined to be concerned about inflation when money is growing abnormally fast; especially, when the rapid growth is the consequence of central bank monetary policy. The reason is the theoretical link between money and inflation is strong. Specifically, the price level is the price of goods and services in terms of money, so there is a direct link between money and prices.

According to the Phillips curve theory, inflation is related to the output gap (the gap between actual and potential output). The theory is based on the idea that there is a limit to how much an economy can produce or how fast an economy can grow. Hence, prices would rise whenever people tried to purchase more output than the economy could provide. Whether such limits exist and what they would be is an interesting metaphysical investigation.


Guest Contributor: The Fed’s Impending Inflation Disaster? (Part 2) - thornton figure 2

Economists have no idea what these limits are or how to measure them.


But, they try. No matter how potential output is estimated it turns out to be little more than a trend measure of real output. Hence, when output goes substantially above its previous trend for a period of time, as it did during the period 1995-2007 (see Figure 2 above), estimates of potential are ratcheted up. Because output has been significantly below estimates of potential since 2007, estimates of potential have been ratcheted down annually (see Larry Summers, Figure 1 below).


Guest Contributor: The Fed’s Impending Inflation Disaster? (Part 2) - summers figure 1

This doesn’t bother true believers.

The Phillip curve theory is nearly always wrong about inflation, but it’s never wrong! It’s a tautology. If the output gap is small and inflation accelerates, believers say “this proves the Phillip curve theory.” If the output gap is small and inflation decelerates, believes say, “the output gap is bigger than we thought.” With this kind of logic, you can never be wrong!

So here is the bottom line of this essay. I don’t know if the massive increase in M1 will ultimately result in an inflation disaster, that’s why the titled of the essay had a question mark. The relationship between M1 and inflation since the early 1980s suggests it won’t. Nevertheless, I believe it is reasonable to sound the alarm because:


  1. There is a direct theoretical link between central bank created money and prices
  2. The increase in M1 that has occurred is unprecedented, and
  3. M1 will continue to grow rapidly so long as the Fed’s balance sheet remains large.


This is a Hedgeye Guest Contributor research note written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.

6 Videos: What's On HedgeyeTV

Our deep bench of analysts take to HedgeyeTV every weekday to update subscribers on Hedgeye's high conviction stock ideas and evolving macro trends. Whether it's on The Macro ShowReal-Time Alerts Live or other exclusive live events, HedgeyeTV is always chock full of insight.


Below is a taste of the most recent week in HedgeyeTV. (Like what you see? Click here to subscribe for free to our YouTube channel.)





1. ICYMI: Are You Bullish On The U.S. Dollar Yet? (1/6/2016)



Here's why this week's Jobs Report is bullish for the U.S. Dollar. (Click here to read a more detailed write-up.)


2. McCullough: This Book Is The ‘Bible’ of Financial Market Knowledge (1/6/2016)



Need to get up to speed on the complex, inner workings of financial markets? We’ve got the book for you. Check out The Misbehavior of Markets by deceased mathematician and deep-thinker Benoit Mandelbrot.


3. What to Watch Ahead of Tomorrow’s Jobs Report (1/5/2016)



Since February 2015, the year-over-year growth (or rate of change) in jobs has been slowing, from that peak of 2.58% to the November reading of 1.58% (see the brief video above for more). (Click here for a more detailed write-up.)


4. How to Trade Gold Right Now (1/4/2016)



As you can see in the video above, the U.S. Dollar has a negative correlation of -0.97 to Gold over the past 90 days, meaning their prices move in direct opposition to each other. Pay attention to the 10-year Treasury yield and direction of the U.S. dollar — both are expressions of future growth expectations.


(Click here for a more detailed write-up.)


5. Here’s The Only Emerging Market We Like Right Now (1/3/2016)



As Hedgeye Senior Macro analyst Darius Dale puts it succinctly in the video above, the Russian economy is growing and you could also get some “goodies from the Trump White House as well.”


6. ‘You Gotta Love Brexit’ (1/3/2016)



“In sharp contrast to the politicized-fear-mongering about Brexit, the British economy chugged along at +2.2% year-over-year growth in Q3. That was even better than the USA’s +1.7% year-over-year growth rate,” Hedgeye CEO Keith McCullough wrote recently. In other words, the U.K. economy is accelerating.


We like Britain’s pound on the long side (especially against the euro).



Click here to subscribe for free to our YouTube channel.

U.S. Jobs Growth Is (Still) Slowing... But Look Out For A Bottom in 2017

U.S. Jobs Growth Is (Still) Slowing... But Look Out For A Bottom in 2017 - jobs report image

The U.S. labor market may be bottoming.


The Bureau of Labor Statistics, which is charged with calculating monthly jobs gains, released the December Nonfarm Payroll report (a.k.a. the U.S. jobs report) on Friday showing 156,000 new jobs were added in the month.


This headline number misses the big picture. As you can see in the Chart of the Day below, year-over-year jobs growth (which removes ambiguity around monthly fluctuations) peaked at 2.3% in February 2015 and has slowed ever since. Friday's December labor market check-up continued this trend, slowing to 1.51%. (Click here to read a brief primer on the misleading nature of the BLS's jobs report.)

Some Sectors of the  economy Already Bottomed... Jobs Growth to Follow in 2017?

#GrowthAccelerating #JobsGrowth #NFP


The jobs report is a late cycle indicator. This means, at the end of the U.S. economic cycle, before a recession, jobs growth are among the last data points to go negative. Conversely, manufacturing economy barometers, like Industrial Production and ISM Manufacturing, are cyclical or leading indicators, meaning they are the first to peak and rollover before the U.S. tips into economic contraction.


Interestingly, these cyclical indicators appear to have bottomed sometime around August and September of last year. The U.S. economy accelerated in the third quarter of 2016 after slowing for five consecutive quarters. In other words, the probability that labor market growth will also bottom between January and May of 2017 is rising. 

Where Do We Go From Here: A History of Jobs Cycles

As you can see in the chart below, jobs growth has been positive for 22 consecutive months in the current cycle. That's fairly long by historical standards. But the precedent for further expansion, into mid-2017, may be the 1990s. From 1991 to 1999, jobs growth was positive for 30 months straight. 


In short, there is an argument to make for further job growth. And since the cyclical side of the economy has already bottomed out, the flow-through to jobs is pretty simple.


U.S. Growth Accelerating = Jobs Growth


U.S. Jobs Growth Is (Still) Slowing... But Look Out For A Bottom in 2017 - NFP YoY CoD 1 9 16

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Keith McCullough's Daily Trading Ranges

Keith McCullough's Daily Trading Ranges - Bull and bear extra cartoon

This post contains today's Daily Trading Ranges, Hedgeye CEO Keith McCullough's proprietary "buy and sell" levels on major markets, commodities and currencies.

This Radical Change is Reshaping the Restaurant Industry… Here’s What It Means for Domino’s | $DPZ


Change is coming to the restaurant industry that will reshape how diners order food. In the coming years, food delivery will be “the most disruptive change in the restaurant industry in this generation,” says Hedgeye Restaurants analyst Howard Penney.


The winners and losers of this trend are becoming more apparent with each day. So far, early adopters like pizza chain Domino’s Pizza (DPZ) have been the prime beneficiaries. In the past year, shares of Dominoes are up 46%, with the company’s innovative food delivery technology bolstering the bottom line. Delivery accounts for 29% of the company’s business and annual digital sales total about $4.7 billion.


However, Domino’s competitive edge is fading fast.


There has been a spread of third party delivery services like DoorDash and Postmates which have received considerable venture funding, and partnered with many independents and large national chains. Historically, GrubHub has merely been an aggregator of orders. But now it’s diving into the delivery space.


Even more traditional restaurant chains like Panera Bread are getting in on the action, Penney explains in the video above. The bakery-café fast casual restaurant has been investing immense amounts of capital to push out their “Panera 2.0 initiative,” which is nearly completed in company-owned stores next frontier is delivery. The company anticipates it will be in 15% of units by the end of 2016, and ramping to 35% - 40% of the system by the end of 2017.


“We have no particular call on Domino’s right now,” explains Penney, “but the more money that’s invested in this business, and as long as companies like Panera continue to go on TV and start talking about delivery in their advertising, it’s going to change the story around the Domino’s business longer-term.”


It will be tough to unseat Domino’s as top-dog in delivery over the short-term. Over the long-term, the company will feel the pressure of competition. This should benefit new entrants, like Panera (PNRA), while squeezing companies with lofty delivery goals, like GrubHub (GRUB).


We are keeping  a close eye on this trend.


Will Trump Be More JFK or Eisenhower On Foreign Policy?

Will Trump Be More JFK or Eisenhower On Foreign Policy? - trump eis or jfk

Hedgeye National Security analyst LTG Dan Christman USA Ret. dissects the "grand vision" that will shape President-elect Donald Trump's foreign policy agenda. On this grand vision, "two presidential narratives have competed for over half a century," Christman writes, Eisenhower and Kennedy. Christman thinks Trump is more like Eisenhower. Here's why.