Get Ready for an L-Shaped Recession, Warns Credit Suisse

A deep recession and then little growth may be what’s needed to fight today’s high inflation, says strategist Pozsar.




Everyone is talking about the possibility of a recession. Almost half the economists in a Bloomberg survey think one will happen within the next year. But few are picturing a very severe downturn.

So now comes a prediction that the next economic slide will be rip-snorting bad. Zoltan Pozsar, Credit Suisse’s global head of short-term interest-rate strategy, declared in a research paper that the current high inflation will require an L-shaped recession—a vertical plunge followed by a long period of stagnation.

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Fed Chair Jerome Powell is aiming for a “soft landing” for the economy as he raises interest rates to bring down inflation, now running at a torrid 9.1% annual pace. But to Pozsar, “there is nothing ‘soft’ about a vertical drop.”

Certainly, his views are at odds with the current bond market, futures market and the Fed, which don’t anticipate much damage, if any, from higher rates.

Due to macroeconomic changes, though, the Credit Suisse strategist wrote, the Federal Reserve will be forced to increase its benchmark rate to 5% or 6%. Current estimates call for around 3.5% as a peak (it’s now in a range from 2.25% to 2.5%).

Pozsar indicated that Powell and the policymaking Federal Open Market Committee will end up resembling Paul Volcker, the Fed chief who vanquished high inflation in the early 1980s with even higher rates, thus triggering two recessions.

“To date, I haven’t heard anything from the FOMC that would suggest that the Fed wants to avoid a recession,” Pozsar commented. And he also has seen no evidence “that the Fed would rush to cut rates if we had a recession with high inflation.”

The macro shift at the center of today’s persistent inflation is that the era when China produced low-cost goods and Russia pumped cheap oil has ended, he said. Now, he observed, an economic war between the West and a China-Russia entente has altered the dynamic massively.

“War is inflationary,” Pozsar argued. “Think of the economic war as a fight between the consumer-driven West, where the level of demand has been maximized, and the production-driven East, where the level of supply has been maximized to serve the needs of the West.” Then, he added, “East-West relations soured, and supply snapped back.”

The upshot, he said, is that the Fed will have little choice. “Interest rates may be kept high for a while to ensure that rate cuts won’t cause an economic rebound (an ‘L’ and not a ‘V’), which might trigger a renewed bout of inflation,” Pozsar went on.

“The risks are such that Powell will try his very best to curb inflation, even at the cost of a ‘depression’ and not getting reappointed.”

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Justice Department Ends Investigation of Pennsylvania PSERS

A 2020 accounting error had prompted the investigation that lasted for more than a year.


The Department of Justice has dropped its investigation into the Pennsylvania Public School Employees’ Retirement System, said Chris Santa Maria, chairman of the $75.9 billion pension fund’s board of trustees, in a statement. PSERS made no further comment on the matter.

 

The pension fund had been under investigation by the Justice Department since at least May of last year, when subpoenas indicated that the FBI and prosecutors were seeking evidence of kickbacks and bribes at PSERS.

 

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The subpoenas were reportedly looking for information from the pension fund, its executive director, chief financial officer, chief auditing officer and deputy CIO. The court orders reportedly showed that the FBI and prosecutors were probing possible “honest services fraud” and wire fraud.

 

The investigation was related to an incident in December of 2020, when PSERS’ board of trustees certified the contribution rates for its members. The board was told by its general investment consultant and another firm that the retirement system’s nine-year performance figure was 6.38%, which was just high enough to avoid triggering additional contributions under state law.

 

However, during a March 2021 board meeting, PSERS management informed the board that there were errors in the data used to perform the calculation. As a result, the board ordered a review of all performance data and found that the actual nine-year performance figure was 6.34%, which meant an automatic increase in contributions since the number fell short of the 6.36% target. Under the state’s “risk sharing” law, school employees and taxpayers have to contribute more when the pension’s investment portfolio underperforms.

The miscalculation forced the board to recertify the member contribution rate, which led to thousands of teachers having to pay more in employee contributions. As a result, the board of trustees hired two law firms to investigate the misstatement. After the error came to light, both CIO Jim Grossman and Executive Director Glen Grell resigned late last year.

According to a report released earlier this year following an internal investigation, PSERS investment consultant Aon took responsibility for the accounting error. The report includes a letter from Aon to Grossman that said the firm had become aware of data corruption in some sub-composite market values, cashflows and returns for April 2015.

 

Aon attributed the data corruption to an error by an analyst in uploading net asset value and cashflow data into the performance system it uses. The company said the data corruption impacted “a few asset class composites” in the public markets.

 

No one at PSERS has been accused of any wrongdoing.

 

Related Stories:

FBI Said to Seek Evidence of Kickbacks, Bribery at Pennsylvania PSERS

Pennsylvania PSERS Hires Law Firms to Probe Reporting Error

CIO, Executive Director Resign From Embattled Pennsylvania PSERS

 

 

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