How Escalating Inflation Can Produce a Recession

As Federal Reserve policymakers gather this week, apparently intent on raising interest rates to fight spiraling inflation, while war shakes eastern Europe and other possible calamities lurk, talk of recession has appeared on Wall Street.

Of all the malign factors that could propel the U.S. into an economic downturn, inflation is the most threatening, in the estimation of Joseph Lavorgna, Natixis’ chief economist, Americas.

Even if the Ukraine war is resolved, March and April inflation rates are likely to keep swelling, he argues in a research note. He worries that the Fed will tighten too much and shrink gross domestic product. “This is why today’s high inflation rate, which is poised to go higher, and a hawkish Fed are such a concern,” he writes.

Lavorgna fears that the Consumer Price Index, which jumped to a 40-year high of 7.9% in February, will “increase to a staggering 8.5%” in March, and perhaps keep rising. The 7.9% CPI figure was reached before this month’s sharp run up in energy and other commodities, he points out.

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Nondiscretionary spending—for the likes of food, energy, and shelter—has risen to 24% of household income, from 20% a year ago. Lavorgna warns that if nondiscretionary outlays climb to 28%, the result would be bad.

This would be the equivalent of a $750 billion tax increase, he calculates. Should that occur, he observes, “How could the economy possiblyavoid a downturn?”

The price boosts are across the board, the most recent CPI reading shows, and Lavorgna remarks that unlike “in the past, food is rising alongside energy.”

“Will this make the Fed more aggressive at a time when the economy is already markedly slowing?” he asks.

The Federal Reserve’s policymaking panel on Wednesday is expected to announce a quarter percentage point boost in its benchmark federal funds rate, which calls the tune for short-term interest rates. This elevation from today’s near-zero level, in place since the pandemic’s onset, is the first in a series of hikes that the central bank is poised to roll out, in a bid to combat the higher inflation.

Meanwhile, projections for GDP are shrinking. The Atlanta Fed’s GDP Now estimate for this year’s first quarter showed an almost 2% annual growth a month ago. Now it is 0.5%. Other forecasters are more sanguine. Morgan Stanley, for instance, thinks that the current quarter will show a 2.9% expansion. Compare that with 2021’s economic growth, a robust 5.7%.

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Tags: CPI, energy, Federal Reserve, food, GDP, Inflation, Interest Rates, Joseph Lavorgna, Natixis, nondiscretionary spending, recession, shelter, war

Brad Lander wants the city’s pension funds to be able to invest more in alternative assets. Last year he called some of them ‘risky and speculative.’

New York City Comptroller Brad Lander appears to be warming up to alternative investments.

Lander, who is custodian of the $274.7 billion in assets held by New York City’s five public pension funds, recently called for state lawmakers to update a law and increase the amount the city’s pension funds can invest in alternative assets to 35% from 25%. He said that if this could not be done, then the cap on global equities should be raised to 30% from 10%.

Lander recently testified before the state legislature and requested a refresh of the so-called “basket clause.” The basket clause allows up to 25% of a New York public pension fund’s assets to be allocated to investments not otherwise expressly authorized by state law, or that exceed permitted percentage limitations. He said the law “fails to reflect the realities of the modern investment world and hampers our ability to prudently diversify our portfolio, maximize our risk-adjusted returns, and save money in the long term.”

Lander said that “either of these requested legislative changes would allow public pension funds in New York State to prudently diversify their portfolios based on current market conditions and obtain potentially greater returns while maintaining a consistent, prudent level of risk.”

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In his speech, Lander pointed out that he is not alone in seeking out higher returns through private investments, as many pension funds and endowments currently invest more than 25% of their portfolios in assets that would count against New York’s basket clause. Lander lauded Yale University’s $42.3 billion endowment, noting that it has well over half of its investments in private assets and “has achieved returns that consistently outpace other portfolios.”

Times have changed, he said, as institutional investors are unlikely to be able to invest as they have in the past while also meeting return targets. Despite a record-breaking year for many institutional investors in 2021, the general consensus among economists is that investors need to prepare for a low-return environment, which is spurring many to seek out higher returns.

However, Lander’s testimony strikes a different tone than the strategic plan he released last year when running for office, in which he said he would consider reducing the city’s pension fund investments in private equity and hedge funds. He also referred to hedge funds, private equity, and private real estate funds as “risky and speculative” in an April 2021 press release that accompanied the plan.

“A portion of the city’s pension funds are in riskier assets such as hedge funds, private equity, and private real estate funds,” Lander’s plan said. “Due to the highly speculative and often extractive nature of these investments, and the high fees some charge, the strategic planning process will examine the full costs and benefits of the funds’ alternative asset allocation strategies.”

The basket clause at issue also restricts investments in a wider set of asset classes, such as alternative credit, global equities, and infrastructure. That means that by raising the cap on the basket clause, Lander can also seek out higher returns by increasing the diversification of the city’s assets.

Lander declined to comment for the story.