Stock prices and the mean expected NGDP growth rate continued their nearly inexorable rise last week, as another net positive real shock occurred, despite a sharp rise in oil prices. Year-over-year Q4 real GDP surprised on the upside, at over 3.3%, continuing an upward trend that began 5 quarters ago. This is while NGDP has trended down over the same period.
Indeed, there’s been significant supply-side healing over the past 5 quarters, as “transitory” factors contributing to inflation subsided. That’s not to downplay the Fed’s overshooting during the pandemic, but to say that there was no reason for the Fed and Treasury to completely abandon the focus on transitory inflation.
None of this should be surprising to readers of this blog, as markets have been telling us this the whole time. Particulary relevant here is the 5-year inflation breakeven, which has remained well-below current core inflation rate since inflation began exceeding the Fed’s mean target during the pandemic.
The 5-year breakeven told me that inflation was too high by late 2022, but I was slow to accept its message, being too confident that real GDP potential was higher than commonly thought, and hence didn’t begin to become concerned until the rate started to approach 3%.
While I still believe that real GDP potential is higher than thought before the pandemic, I can’t discount the credible possibility that permanent supply-side damage will limit real growth somewhat going forward. This could involve the shifted supply-chains, in response to both the pandemic and the rising tensions with China, for example. Another apparent drag on future growth could be a declining EPOP. After climbing above the pre-pandemic high briefly last year, various measures of the EPOP have been trending down since.
Also, there is some considerable evidence that real growth is expected to soon slow down for years. Here’s the latest Fed Funds futures curve, for example:
Notice, however, that the Fed Funds rate is expected to begin rising again after it bottoms in 2026. Could this signify an expected productivity J-curve? Perhaps the AI-fueled boom will take a couple of years longer than expected to begin boosting growth.
So, on net, these are some considerable clues that long-run real growth is expected to be higher going foward than during the Great Recession aftermath, and indeed, higher than many estimates prior to the pandemic. And, since there may still be room for some more positive real shocks, such with regard to commodity prices, stock prices still plausibly have room to run.
The usual caveats apply, of course. Increasing instability in the world poses many risks to real growth.
Note: This post, as is the case with all my posts, should not be construed as offering investment advice. Such advice should be tailored to the individual investor by qualified professionals who, ideally, are fiduciaries.
Links to Data: