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There is an ongoing debate about whether the current high levels of inflation are the result of aggressive monetary and fiscal policy or supply chain problems and lower labor supply.
A straightforward way to analyze this question is to look at what happened to aggregate demand and aggregate supply during covid.
Demand: The size of the fiscal and monetary policy response to covid at $10trn was very significant, or about 40% of 2022 GDP, see the first chart. The magnitude of these numbers suggests that demand is playing a key role as a driver of inflation.
Supply: The CBO estimates that the covid shock, combined with the fiscal and monetary response, has increased the overall capacity of the US economy, see the second chart which shows that the CBO’s current estimate of potential GDP in 2023 is higher than the estimate for potential GDP in 2023 they had in 2019. In other words, the covid shock did not lower the capacity of the US economy.
The bottom line is that while supply chain problems initially boosted inflation, the current high level of inflation is the result of easy money and fiscal policy, not because of a decline in the capacity of the US economy.
Source: FRB, BEA, Haver Analytics, Apollo Chief Economist 
Source: CBO, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The Fed conducts an annual survey of the financial well-being of US households, and the latest survey shows that consumers are happy with their own finances. But they are unhappy with the national economy, which is consistent with households facing high inflation yet still have jobs and plenty of savings.
Source: FRB, Apollo Chief Economist See important disclaimers at the bottom of the page.
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There are two downside risks to the outlook for the economy and markets.
The first is rates higher for longer because of sticky inflation driven by high wage inflation and the ongoing recovery in the housing market.
The second is the ongoing tightening in credit conditions with banks holding back lending.
We are carefully monitoring both of these risks.
Our banking sector outlook is available here.
Source: FRB, Haver Analytics, Apollo Chief Economist 
Source: Conference Board, FRB, Haver Analytics, Apollo Chief Economist 
Source: ICE BofA, Bloomberg, Apollo Chief Economist. Note: Unweighted average spreads of bonds from ICE 5-10 Year US Banking Index, C6PX Index for bonds issued before 1st Jan 2023. There are 8 banks in the Regional index and 41 banks in the Diversified index, and Regional banks include BankUnited, Citizens Financial, Huntington, and Zions, and Diversified banks include JP Morgan, Citibank, and Bank of America. 
Source: Federal Reserve Board, Haver Analytics, Apollo Chief Economist. Note: March data as of 10th May 2023. Peak is defined as the month before monthly outflows turn negative. 
Source: FRB, ICI, Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The consensus has been forecasting negative growth since October 2022, and the recession has yet to arrive because it has taken longer to run down excess savings in the household sector, see chart below.
Put differently, it is taking longer to remove from the economy the $5trn fiscal and $5trn monetary expansion done during covid.
On the back of stronger-than-expected growth, the correction in stock markets and credit spreads has been relatively limited despite the rapid increase in short rates.
With inflation still at 5%, far above the Fed’s 2% inflation target, the Fed will keep the costs of capital high, and the recession will come as households eventually run out of excess savings.
The implication for markets is that the Fed will continue to put downward pressure on earnings growth and employment growth until they get what they want, namely lower inflation.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The BoJ will likely exit yield curve control later this year. This presentation looks at what the consequences will be for USDJPY, US credit, and US rates.
See important disclaimers at the bottom of the page.
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My latest outlook presentation is available here.
See important disclaimers at the bottom of the page.
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The interest coverage ratio for the investment grade index is currently near all-time high levels, see chart below.
Source: Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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What makes the coming recession so unusual is that it is happening after almost 15 years of money printing, which never really had any major positive effect on GDP growth. Instead, the 15 years of money printing created a significant bubble in asset prices.
As a result, the big correction during this recession will not be in the economy but in asset prices as the Fed continues to deflate the buy-everything bubble created due to global easy money.
A mild economic recession with a big recession in asset prices is what we call a non-recession recession.
With inflation currently at 5%, well above the Fed’s 2% inflation target, the ongoing correction in asset prices will continue as the costs of capital will stay elevated well into 2024.
Source: BEA, Haver Analytics, Apollo Chief Economist. Note: Estimates shown for real GDP and nominal GDP are for the period covering the peak-to-trough decline in real GDP. Unemployment rate is trough to peak. See important disclaimers at the bottom of the page.
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The stock of CRE debt outstanding today is significantly smaller than the stock of residential mortgage debt outstanding in 2007, see chart below.
As a result, this recession will be milder than in 2008, but it will likely be longer because the required correction in CRE prices will be spread out over a longer period.
Source: BEA, FRB, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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A survey of 67 banks in the Dallas Fed district carried out in early May shows that credit standards have tightened significantly since SVB collapsed, and bank credit conditions are now at 2020 levels, and the deterioration continues, see chart below.
Combined with still tight IG and HY spreads, the Fed will look at this and conclude that tighter credit conditions are needed to get inflation down from currently 5% to the Fed’s 2% inflation target. In particular in a situation where households are still sitting on plenty of cash, see also this new Fed working paper, which finds that consumers have plenty of excess savings left at least until the end of the year.
Source: Banking Conditions Survey, Federal Reserve Bank of Dallas, Apollo Chief Economist. Note: Data were collected May 2–10, and 67 financial institutions responded to the survey headquartered in the Eleventh Federal Reserve District. See important disclaimers at the bottom of the page.
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