The US Indo-Pacific Command on Thursday revealed a prior close-call, dangerous incident between US and Chinese military aircraft. Specifically the direct aerial encounter from last week, now confirmed for the first time, disrupted the operations of a US Air Force spy plane while flying over international waters of the South China Sea.

The US military statement said a RC-135 Rivet Joint aircraft was intercepted by a Chinese PLA Navy J-11 fighter jet on Dec.21, with the Chinese aircraft having come within a mere 20 feet of the US surveillance jet, forcing the US plane to take quick evasive maneuvers.

The Indo-Pacific Command statement begins by describing that “On Dec. 21 a People’s Liberation Army – Navy J-11 fighter pilot performed an unsafe maneuver during an intercept of a U.S. Air Force RC-135 aircraft, which was lawfully conducting routine operations over the South China Sea in international airspace.”

“The PLAN pilot flew an unsafe maneuver by flying in front of and within 20 feet of the nose of the RC-135, forcing the RC-135 to take evasive maneuvers to avoid a collision,” it continues.

The US statement added: “The U.S. Indo-Pacific Joint Force is dedicated to a free and open Indo-Pacific region and will continue to fly, sail and operate at sea and in international airspace with due regard for the safety of all vessels and aircraft under international law. We expect all countries in the Indo-Pacific region to use international airspace safely and in accordance with international law.”

The Pentagon released video of the “unsafe intercept” over the South China Sea…

Dramatic video released by the Pentagon the same day shows the Chinese J-11 fighter come terrifyingly close to the American aircraft, as the footage taken by a US pilot directly from within the RC-135 cockpit shows.

These types of close proximity intercepts have happened before over waters off China, but sill remain very rare, and we should add serious – given the potential for aerial collision or incident at a moment US-China tensions are on edge especially over Washington’s defense support to Taiwan. One prior 2017 incident even involved Chinese fighters reportedly giving a US plane the “Top Gun treatment”, something the US pilot in this latest close-call was at least thinking…

FTX founder and accused crypto-crook Sam Bankman-Fried met with senior White House officials on at least four occasions in the months leading up to his firm’s massive implosion, Bloomberg reports.

On Sept. 8, SBF met with senior Biden adviser Steve Ricchetti in a previously unreported encounter, White House officials familiar with the matter said. The meeting was “the latest in a handful of sessions,” according to the report.

Bankman-Fried had at least three others previously disclosed in White House visitor logs. They include one April 22 and another May 12, each with Ricchetti, and one a day later, on May 13, with Bruce Reed, another senior Biden aide, officials confirmed. The final meeting is recorded in logs as two meetings held back-to-back, but was one meeting, officials said. Some of the prior White House meetings included others from FTX. -Bloomberg

What’s more, Bankman-Fried’s brother, Gabriel, held a March meeting of his own and was also at the May 13 meeting – bringing the total number up to five meetings that involved one or bother brothers. 

I am sure he called the main line and spoke to an operator to get through.

— Dumb Alpha (@_dumbalpha) December 29, 2022

According to one source, “politics” were not discussed despite SBF being a Democrat megadonor credited as a major factor in President Biden’s 2020 win. Instead, the brothers allegedly talked about general matters related to the ‘crypto industry and exchanges,’ as well as “pandemic prevention related to the foundation, Guarding Against Pandemics, run by Gabe Bankman-Fried,” according to an official.

According to anonymous sources the conversation between two foxes in the henhouse did not involve dinner.

— Bill Kehler (@BillKehler2) December 29, 2022

SBF now faces several criminal charges related to the collapse of FTX. His ties to Washington have come under the microscope since the collapse of his exchange – as Bankman-Fried gave millions of dollars to Democratic politicians – becoming the party’s second-largest individual donor in the 2022 session.

One person familiar with the meetings, speaking on condition they not be identified, said that politics was not discussed at the White House meetings.

While Bankman-Fried, or SBF as he’s known, lived in the Bahamas, he made frequent trips to Washington — testifying before Congress and meeting with key regulators, including the Securities and Exchange Commission and the Commodity Futures Trading Commission, as well as with White House officials. -Bloomberg

According to US prosecutors, SBF allegedly conspired with others to use corporate funds and shadow donors for political contributions, and illegally commingled billions of dollars of customers’ funds lent to his trading arm, Alameda Research.

This is fucking disgusting and proves outright corruption. White House met with bankman-fried (SBF) before the FTX collapse. https://t.co/9s8FhKU24M

— Scrubby Trader (@ScrubbyTrader) December 29, 2022

Authored by Katabella Roberts via The Epoch Times,

Brazilian Supreme Court Judge Alexandre de Moraes issued a temporary firearms ban in Brasilia, the capital of Brazil, on Wednesday ahead of the Jan. 1 inauguration of President-elect Luiz Inacio “Lula” da Silva.

The decision was made as a precautionary measure, according to the judge, and will last until Jan. 2, the day after the inauguration.

Those who violate the ban risk being arrested. Members of law enforcement and security forces are exempt from the ban, as are those employed by private security companies.

Specifically, the temporary ban suspends licenses that allow hunters, marksmen, and collectors to carry guns and ammunition in the region.

In his ruling, de Moraes said the ban was needed to ensure public safety after a rise in the number of “terrorist groups financed by shameless magnates” committing crimes in recent weeks, CNN reported.

Incoming Justice Minister Flavio Dino said that da Silva’s team had requested the gun restrictions be put in place. Dino also praised the move for bolstering security at the inauguration.

Tensions have been running high in Brazil since da Silva’s victory against conservative incumbent Jair Bolsonaro was certified on Dec. 12. Thousands of Bolsonaro supporters across the country have been protesting the results of the election over claims of fraud and calling for the military to intervene.

Lawyers for Bolsonaro later challenged the outcome of the election and requested that the electoral authority invalidate the votes cast on some of the country’s electronic voting equipment.

That challenge was rejected by de Moraes. Bolsonaro has not yet conceded the results of the election.

Brazilian President and reelection candidate Jair Bolsonaro (L) in Brasilia, Brazil, on Oct. 2, 2022. (Evaristo Sa/AFP via Getty Images); Former president of Brazil and candidate of the Worker’s Party Luiz Inacio Lula da Silva in Sao Paulo, Brazil, on Oct. 2, 2022. (Alexandre Schneider/Getty Images)

Registered Gun Owners Rise in Brazil

The number of registered gun owners in Brazil jumped six-fold to about 700,000 under Bolsonaro’s efforts to relax gun laws, beginning in 2019.

Shortly before the ruling to ban guns in the capital, police arrested a 54-year-old gas station manager over his alleged planting and possession of explosive devices at Brasilia International Airport.

The suspect allegedly told police that he planned “to provoke a military intervention and the decree of a state of siege to prevent the installation of communism in Brazil.”

Da Silva and his Workers Party led Brazil for two terms from 2003 to 2010, during which he implemented a string of social justice policies, including anti-hunger and income-transfer programs in which the government subsidized electricity and food prices and transferred cash to the poor.

He also helped establish relations with other BRICS countries: Russia, India, China, and South Africa.

However, he was banned from returning to power in 2018 after he was convicted on charges of money laundering and corruption at the state-owned oil and petrol company, Petrobrás. He was subsequently sentenced to 12 years in prison following an investigation into the scheme.

Throughout his time in prison, da Silva maintained his innocence and called the case against him politically motivated. His conviction was later overturned by the Supreme Court when seven of 11 justices agreed that he should be tried in the state in which he lives as opposed to the state in which he was accused.

A new trial has not yet been scheduled in court regarding the charges.

The US Virgin Islands is suing JPMorgan Chase for allegedly reaping financial benefits from Jeffrey Epstein’s pedo sex-trafficking operation and failing to report suspicious banking activity.

“Over more than a decade, JPMorgan clearly knew it was not complying with federal regulations in regard to Epstein-related accounts as evidenced by its too-little too-late efforts after Epstein was arrested on federal sex trafficking charges and shortly after his death, when JPMorgan belatedly complied with federal law,” said US Virgin Islands Attorney General Denise George in a Thursday complaint reported by CNN.

The new lawsuit comes less than a month after Epstein’s estate settled with George for over $105 million dollars, along with an agreement that the estate will liquidate Epstein’s islands and cease business operations in the region.

“Human trafficking was the principal business of the accounts Epstein maintained at JPMorgan,” reads the filing.

The lawsuit claims that JPMorgan Chase failed to make proper regulatory filings that could have tipped off the government to Epstein’s alleged sex-trafficking ring of underage girls through private islands he owned in the U.S. Virgin Islands. In particular, the government argues that JPMorgan Chase should have given Epstein closer scrutiny as a client after he entered a guilty plea to soliciting prostitution with a minor in Florida in 2008. -CNN

The bank had no comment as of Wednesday evening.

The lawsuit comes after two anonymous Epstein victims slapped JPMorgan and Deutsche Bank with civil lawsuits which claim that the banks enabled and benefited financially from Epstein’s sex trafficking operation.

According to the civil suit, JPMorgan is accused of having “provided special treatment to the sex-trafficking venture, thereby ensuring its continued operation and sexual abuse and sex-trafficking of young women and girls.”

“Without the financial institution’s participation, Epstein’s sex trafficking scheme could not have existed,” the filing continues.

Epstein was awaiting trial in 2019 on federal charges accusing him of operating a sex trafficking ring between 2002 – 2005 across several properties, when he was found dead in his prison cell.

Authored by NAMCIOS via BitcoinMagazine.com,

Newly elected Fiji Prime Minister Sitiveni Rabuka is pro-Bitcoin and is reportedly considering pushing a bill to adopt BTC as legal tender in the country…

Pro-Bitcoin politician Sitiveni Rabuka recently took office as the new Prime Minister of the Pacific Islands of Fiji. Now, it seems the new PM is actively considering the adoption of bitcoin as legal tender there.

While Rabuka himself hasn’t been very public about his opinions on Bitcoin thus far, Lord Fusitu’a, a noble and former member of parliament of neighboring nation Tonga, has reportedly confirmed that the Fijian politician is a bitcoin bull.

“The new PM is definitely pro-Bitcoin,” Lord Fusitu’a assured Cointelegraph.

Lord Fusitu’a also shared the news on Twitter.

“A new pro-#Bitcoin friendly Prime Minister in the South Pacific. Fiji’s newly elected Prime Minister @slrabuka,” Lord Fusitu’a wrote, tagging Rabuka.

In the second part of his tweet, Lord Fusitu’a hinted at the legal tender legislation.

“Let’s go 2 for 2 – BTC Legal Tender Bills for the Pacific in 2023,” the tweet reads, hinting at Tonga’s own Bitcoin legal tender legislation that could reportedly go live as early as Q2 2023.

The Bitcoin dream first started brewing in Tonga right after El Salvador’s Bitcoin Law came into effect.

Now, Fiji could be next in bringing BTC under its definition of legal tender. Lord Fusitu’a told Cointelegraph that Fiji’s new Prime Minister “asked to meet with me which we did via zooms since last year to walk him through step by step, how he could adopt bitcoin legal tender.”

Both countries could benefit tremendously from bitcoin adoption in two specific areas; remittances and mining.

Remittances sent to Fiji accounted for 11.3% of the country’s gross domestic product (GDP) in 2021, per World Bank data. Tonga’s situation is even more dramatic –– remittances were a whopping 45.5% of the nation’s GDP in 2021.

When it comes to mining, both countries can take advantage of their geology. Being volcanic islands, there is a lot of opportunity to experiment with and profit from bitcoin mining. Moreover, Fiji also boasts significant hydro capacity.

Russia’s Engels airbase has been targeted for a third time this month by Ukraine’s military, resulting in Russian anti-air defenses being activated to take out an inbound projectile. 

Engels airbase is located in the Saratov region and crucially is at a distance of over 600km from the Ukrainian border. “The air defense system has been activated in the Engels district,” regional governor Roman Busargin said of the Thursday incident. 

Busargin described that an “unidentified object” had been destroyed, adding that there is no further threat to civilian safety. He didn’t indicate whether the object was a drone or missile, but it comes after a deadly Monday attack involving a Ukrainian drone. 

No casualties are being reported from the Thursday attack, but Monday’s drone assault left three Russian servicemembers dead, according to state news agencies, after an enemy drone was reportedly intercepted, causing debris came down on bystanders below. 

“On December 26, at around 01:35 Moscow time, a Ukrainian unmanned aerial vehicle was shot down at low altitude while approaching the Engels military airfield in the Saratov region,” the Russian defense ministry said in a prior statement.

Many outside observers doubted Russia’s intercept story, given also local videos seemed to show explosions more consistent with a direct hit.

On Dec.5 Ukraine’s military mounted simultaneous drone assaults on an air base in Ryazan, in western Russia which hosts nuclear-capable strategic bombers, and also Engels base.

That initial Engels strike had constituted the deepest the Ukrainians had ever attacked inside of Russia proper.

More images of the air defence launch. Russians and their smart phones. pic.twitter.com/iXq48WocBL

— Artoir (@ItsArtoir) December 29, 2022

Feeling emboldened by a handful of successes, including prior attacks and bombings in Crimea, Ukraine forces will likely try to continue hitting targets inside Russia, also as their capability grows given they have been supplied with ever-longer range rockets from the US and NATO countries.

Russia for its part is continuing to ramp up major missile and drone attacks on Ukraine’s national energy infrastructure. Over 120 missiles launched Thursday has left even Lviv in far western Ukraine in the dark, along with about half the capital city and other places like Kharkiv and Odesa. The Pentagon has indicated that Patriot anti-air batteries could be shipped in as little as six months, even though it typically takes one-year minimum to train personnel on how to operate them.

Authored by Mike Shedlock via MishTalk.com,

Think carefully about my question and the measures you use to define inflation.

Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon.” 

M2 from the Fed, CPI from the BLS, Monthly Data Through November, Chart by Mish

Most people parrot Friedman because the quote sounds good. 

The actual quote is:

“Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

M2 Weekly Chart Percent Change From Year Ago

M2 from the Fed, Weekly Data Through December 5, Chart by Mish

Last Five Weekly Readings

• 2022-11-07:  0.3 Percent

• 2022-11-14:  0.0 Percent 

• 2022-11-21: -0.1 Percent

• 2022-11-28: -0.4 Percent

• 2022-12-05: -0.7 Percent

Is Inflation Always a Monetary Phenomenon?

If you insist that increases in money supply constitute inflation, then you must also insist that we are in a period of deflation right now.

Does it feel like it?

I have been waiting for this moment for a long time just to ask these questions. 

I was sure money supply growth would go negative because the Fed’s balance sheet unwind would shrink money supply as measured by M2. 

Quoting Friedman 

People love that Friedman quote, but ask anyone: How do you measure money? Is it M1, M2, MZM, or M3? Expect blank stares. 

Then ask them how they measure inflation. If it’s by prices, not increases in money supply, then their answers are inconsistent. 

What About Velocity?

At the time Friedman made his claim, he believed the velocity of money was relatively constant or stable in a narrow band.

Velocity was relatively stable then. It isn’t now. Few are aware of that major difference.

Changing Definitions 

The 1959 Miriam-Webster definition of inflation was an increase in money supply and credit. Apologies offered, but I cannot find that reference. 

The Fed, academia, and governments managed to change the definition to hide asset and credit bubbles.

The Fed seldom if ever discusses money supply or total credit. That is on purpose.

Total Credit Market Debt

Total Credit Market Debt Owed data from the Fed, chart by Mish

TCMDO is $92 trillion. Data is through the third quarter of 2022.

How the heck is that supposed to be paid back? 

From 2006-2009, using a credit view of inflation, I confidently predicted deflation and it happened. 

Will it happen again?

I say yes, but when is the key question. This is not 2008. We do not have the degree of housing liar loans and people walking away from debt.

But we do have masses of zombie corporations that will go bust and all their debt with them. 

Housing Bubble Deflation 2007-2010 Flashback

Total Credit Market Debt Owed and M2 data from the Fed, chart by Mish

That’s one hell of a deflation flashback to the housing bubble bust. We had an unprecedented 4 consecutive quarters of declining credit year-over-year and a 5th quarter that was flat. 

Coupled with an enormous asset bubble bust, that’s deflation by any sensible measure. 

At the time, however, I was routinely mocked for my deflation take because M2 was still positive. Well now it isn’t.  

Is the US in a Period of Deflation Right Now?

The answer depends on what one means by inflation, deflation, and money. If you insist on a M2 measure, there is only one possible answer, and that is yes.

If you point at the CPI or grocery prices today while pointing out M2 yesterday, what does that say about you?

If you view things from the perspective of asset bubbles then heck yes, deflation has started. It also has a long way to go.

If you look at things from a credit perspective, you have a much better leg to stand on if you say there is still inflation. 

Deflation In the Batter’s Box

It’s asset bubble and credit deflations that are the most damaging. Of course, it’s periods of credit inflation and cheap interest rates that sponsor asset bubbles. 

To control inflation, the Fed has popped another asset bubble, largely of its own making. 

Deflation, via another credit bubble bust, is in the batter’s box. 

The Fed would pivot if it causes a credit event, but how low will asset prices go first?

Regardless, if you think either M2 or the CPI is the thing that matters most, you are wrong no matter what the Fed says. 

The credit picture is more important than either of them. So are deflating asset bubbles. The latter is what led to a credit bust in the housing bubble period and it can easily happen again. 

Meanwhile, the Fed is hell bent on destroying asset prices to control inflation. Good luck with that. 

How Did We Get Here?

Why the Fed is in this position for the third time since 2000?

The short answer is the Fed is clueless about what inflation is, how to measure it, and what’s really important. 

The Fed only looks at consumer inflation. It ignored (make that sponsored) asset and credit bubbles in a perpetually foolish effort to promote routine consumer price inflation of 2 percent.

But the Fed can only make money cheap, it cannot control where money goes. The money (credit expansion) went into assets especially housing.

Case-Shiller Home Price Index

Case-Shiller home price data via St. Louis Fed, chart by Mish

CS National ,Top 10 Metro, CPI, OER Index Levels

Case-Shiller home price data via St. Louis Fed, CPI, OER, and Rent from the BLS, chart by Mish

Chart Notes

• OER stands for Owner’s Equivalent Rent. It it the price one would pay to rent a home, unfurnished and without utilities.

• Home prices wildly disconnected from the CPI in 2000 and in 2013. The disconnect accelerated in 2020.

The Fed ignored all three occasions hoping to make up for “lack of inflation”. The Fed “succeeded” beyond it’s wildest dreams. 

For discussion, please see Home Prices Sink in Every Major Market, What About Year-Over Year?

In late 1990s the Fed ignored obvious bubbles and the DotCom mania. Then to bail out banks in the wake of the DotCom bust, the Fed either purposely or ignorantly blew a massive housing bubble.

My chart shows a clear disconnect in housing. The Fed ignored soaring home prices that on the pretense that homes are not a consumer expense and thus not in the CPI.

The Fed made the same mistake, using the same faulty logic in the entire 10-year period from 2012 on. 

The Fed wanted to make up for lack of inflation as measured (idiotically) by the CPI.  

Historical Perspective on CPI Deflations: How Damaging are They?

Hello Fed, it’s not consumer inflation that matters, it’s inflation that matters. 

I have been making that case ever since 2006, to no avail. To become a decision maker at the Fed you have to believe total silliness instead of reality.

I have referred to this article before but now is a great time for a refresher course.

Please consider Historical Perspective on CPI Deflations: How Damaging are They?

Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.

The Bank of International Settlements (BIS) took a look at the Costs of Deflations: A Historical Perspective. Here are the key findings.

Concerns about deflation – falling prices of goods and services – are rooted in the view that it is very costly. We test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt.

Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.

Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI ) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the postwar era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant.

The exception to the general rule was the Great Depression but, that was also an asset bubble deflation coupled with consumer price deflation.

Paying Attention to the Wrong Things

Instead of paying attention to credit growth and asset bubbles, every Fed member is in an echo chamber following useless economic metrics like inflation expectations, the Phillip’s Curve and all sorts of other silliness.

For discussion, please see Inflation Expectations are Crashing. So What? It Doesn’t Matter.

Worse yet, in their attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse, setting off what they should fear – asset bubble deflations.

And here we are, with asset bubble deflation at hand with the Fed wringing its hands over the wrong things, after finally succeeding in creating the CPI inflation that it no longer wants. 

Forget about M2, for now. Watch TCMDO instead. If credit collapses, the economy and the Fed is in deep trouble.

By the way, please note M2 money supply is $21.4 trillion while total credit owed TCMDO is $92.2 trillion. 

Will these converge? Which way, how, and when?

*  *  *

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One year ago in keeping with its annual tradition, Goldman’s economics team published a list of 10 questions and answers for 2022 and while the end results was a mixed bag (professional subs can read the 2022 predictions and their outcome here), where Goldman was catastrophically wrong was in the only item that matters: inflation. Specifically, when asking if core PCE will fall below 3%, Goldman’s rhetorical answer was “yes” and boy was it wrong. And if you got inflation wrong, nothing else mattered (just look at the $20 trillion loss in global market cap as a result of unprecedented central bank tightening).

Of course, being wrong never stopped Goldman before, and earlier this week the bank’s chief economist Jan Hatzius published his list of most pressing questions for 2023, including a discussion on the bank’s most “out of consensus” forecast for the coming year, namely that the US will avoid a recession and will “continue progressing toward a soft landing.” Well, if nothing else, it appears that Goldman wants to extend the tradition of being right about the irrelevant stuff while being dead wrong about what truly matters.

Before we get into the weeds, here is a summary of Goldman’s broader economic outlook as laid out by Hatzius

• Our most out-of-consensus forecast for 2023 is our call that the US will avoid an recession and instead continue progressing toward a soft landing. This forecast partly reflects our view that a period of below-potential growth is enough to gradually rebalance the labor market and dampen wage and price pressures. But it also reflects our analysis that indicates that the drag from fiscal and monetary policy tightening will diminish sharply next year, in contrast to the consensus view that the lagged effects of interest rate hikes will cause a recession in 2023.

• We see the first steps in the rebalancing process this year as quite successful. Our jobs-workers gap has shrunk quickly at little cost, with all of the decline in labor demand coming from a drop in job openings. But there is much further to go in 2023. We expect the jobs-workers gap to narrow steadily next year due mainly to a further drop in job openings, but also to a limited increase in the unemployment rate to just over 4%. Both labor market rebalancing and a more moderate inflation environment should lower wage growth toward a more sustainable rate.

• Supply chain recovery and the deflationary impulse in the goods sector that it promised to bring took much longer than we expected but have finally arrived. We expect this ongoing process to push core goods inflation negative next year, driving most of the decline in overall core inflation. This should help to push elevated short-term inflation expectations back toward normal levels.

• We expect the FOMC to deliver 25bp rate hikes in February, March, and May, and then to hold the funds rate at 5-5.25% for the rest of 2023. We are skeptical that the FOMC will cut the funds rate until the economy is threatening to enter recession, and we do not expect this to happen next year.

• The debt limit likely poses the greatest political risk next year, and we expect it to rival the 2011 episode in its disruption to financial markets and the economy. That said, we do not expect Congress to enact major fiscal changes. Republicans might press for spending cuts in a debt limit deal, but we do not expect substantial cuts next year. The White House might press for increased fiscal support, but this also looks unlikely as we believe a soft landing is more likely and a divided Congress would have difficulty responding to a recession even if one occurs.

Incidentally, while Goldman may be wrong about everything else, we agree that a divided Congress will be unable to respond to a recession (which will occur), which means that the only support possible in 2023 and 2024 will be from the Fed, and yes: the firehose is coming.

Without further ado, here is a look at the top 10 questions (and forecasts) from Goldman’s econ team:

1. Will the US economy enter recession in 2023?

No. The consensus 12-month recession probability stands at 65%, well above our own 35% probability.

Part of our disagreement with consensus arises from our more optimistic view on whether a recession is necessary to tame inflation. We have argued this year that an extended period of below-potential growth can gradually rebalance supply and demand in the labor market and dampen wage and price pressures with a much more limited increase in the unemployment rate than historical relationships would suggest. We see this adjustment process as having gone quite well so far, though there is much further to go in 2023. We agree both that calibrating policy just right to stay on this low-growth path is difficult and that there is still uncertainty about how sticky inflation will prove to be, and for that reason our 12-month recession probability is about double to triple the unconditional historical average.

If views on what it will take to reduce inflation were the sole source of disagreement, then we would expect the consensus Fed forecast to be more hawkish than our own. Instead, both the consensus Fed view and market pricing are a touch more dovish than our forecast of a 5-5.25% terminal rate. This implies that much of the disagreement arises instead from differing views on near-term growth momentum and especially on the lagged impact of the rate hikes already delivered on the economy.

We expect more resilience in underlying demand next year than consensus because our analysis indicates that policy restraint has played a very large role in slowing demand growth this year but will fade quickly next year. Exhibit 2 shows that the combined drag from fiscal policy tightening and from monetary policy tightening via financial conditions has been very substantial but will diminish in 2023.

In contrast, the consensus forecast reflects a view that the “long and variable lags” of monetary policy will push the economy into recession next year. We recently showed that other macro models support the conclusion of our financial conditions index growth impulse model that the peak impact of rate hikes on GDP growth is front-loaded, as shown in Exhibit 3.

Much of the disagreement between our view and the implicit consensus view likely arises from two sources. First, our approach recognizes that rate hikes affect the economy via broad financial conditions as soon as markets anticipate them, which in 2022 was well before they were delivered. Second, some forecasters seem to confuse lags from monetary policy to GDP growth with lags to GDP levels—in fact, Milton Friedman’s famous assessment that policy acts with long and variable lags clearly referred to the time until the peak impact on the level of GDP.

2. Will consumer spending grow at least 1%?

Yes. Real disposable income fell from the spring of 2021 through the summer of 2022 as inflation outran wage growth and special transfer payments included in pandemic relief packages expired. Exhibit 4 shows that we expect real income to rise 3.5% in the year ahead, supported by positive real wage growth, large cost-of-living adjustments on transfer payments including Social Security and food stamps, a jump in interest income, and a decline in the effective tax rate as a spike driven by capital gains and bracket creep reverses. While gains from interest income and tax rate normalization will accrue mostly to high-income households and have less impact on spending, the turnaround in real income is nonetheless a key reason that we have a relatively optimistic 2023 consumer outlook.

The impact of firmer real income growth on consumption should be partially offset by a rise in the saving rate next year. We expect the saving rate to increase in part because higher interest rates have reduced household wealth by lowering home and equity prices, and in part because the lower- and middle-income families that tapped excess savings to support their spending this year as transfer payments expired will have less to draw on next year. One important form that drawing on excess savings has taken is the rebound in consumer credit use, and while it remains below its pre-pandemic level as a share of income, its recent rapid growth rate is not sustainable and will have to slow next year.

We expect these forces to net out to consumption growth of roughly 1.5% in 2023.

3. Will core goods inflation turn negative year-over-year?

Yes. One of our largest forecast misses in both 2021 and 2022 arose from mistiming the supply chain recovery, which was delayed by further global shocks and in turn delayed the disinflationary impulse from the goods sector that we had expected to push core inflation meaningfully lower this year. But now supply chain recovery finally appears to be underway, lowering costs and enabling production of scarce items like autos to recover, as Exhibit 9 shows. As inventories are rebuilt, competition should reverse the scarcity effects that raised retail margins and consumer prices earlier in the pandemic.

More moderate commodity price inflation, falling transportation costs, and downward pressure on import prices from past dollar appreciation should also help to reduce core PCE goods inflation, which has already fallen from a peak of 7.6% year-on-year to 3.8% in November and should turn negative next year. Core goods inflation ran modestly negative last cycle, and we expect it to run somewhat more negative than usual for a while as elevated prices of items like used cars revert to more normal levels.

We expect a more limited decline on the services side, with core services PCE falling from 5% to a still high 4.5% by December 2023, in part due to lags in the official data for the two largest categories, shelter and health care. However, Chair Powell’s recent focus on the sharp decline in alternative measures of rent inflation that will lead the official data by longer than usual suggests that Fed officials are comfortable looking ahead to an eventual deceleration and will not overreact to the lagged official data next year.

4. Will the Fed cut the funds rate?

No. We expect the FOMC to deliver three 25bp rate hikes in February, March, and May, and then to hold the funds rate at 5-5.25% for the rest of 2023. In contrast, market pricing implies a peak funds rate of 4.75-5% and declines to about 4.4% by the end of 2023, as shown in Exhibit 13.

There are two possible rationales for cutting the funds rate in the future. The first rationale would be that if inflation declines, Fed officials might decide that policy does not need to be as restrictive anymore. We are doubtful that the goods-driven decline in inflation that we expect in 2023 would be sufficient to give the FOMC confidence that inflation is moving down in a sustained way, which Powell has said is the criterion for cutting. But more than that, we remain skeptical that the FOMC will cut just for the sake of returning to neutral because we suspect that the Fed leadership does not have enough confidence in its neutral rate estimate for it to exert much gravitational pull on the policy rate.

The second and we think more likely rationale for cutting at some point would be that the economy is entering recession or threatens to do so without an easing in monetary policy. We see this as the more natural path—if tighter monetary policy succeeds in convincingly reducing inflation, we expect the FOMC to just leave the policy rate unchanged until something goes wrong. We have cuts in our forecast over 2024-2026, but we do not intend for the timing to be taken literally and instead think of our path of cuts as a placeholder for an uncertain future date when something goes wrong.

We often caution that market pricing is a probability-weighted average of many scenarios and is not directly comparable to our modal forecast of the Fed path, which assumes that the economy will avoid recession next year. We suspect that the downward slope in the yield curve in 2023 mostly reflects some probability of cuts in a possible recession scenario, while the downward slope in 2024 likely reflects both some probability of cuts in a recession and some probability of cuts if inflation moderates without a recession. Our own probability-weighted average forecast of possible Fed paths also implies that the yield curve should slope downward but is somewhat more hawkish than market pricing.

5. Will the debt limit have as negative an impact on financial markets in 2023 as it in 2011?

Yes. The political and fiscal conditions next year will be similar to the last two extremely disruptive debt limit increases, in 1995 and 2011. Like next year, in those periods a Democratic President in his third year faced a Republican House after losing the majority in the midterm election. Those episodes also followed a run-up in public debt as a share of GDP and/or a rise in federal interest expense, similar to the experience over the last few years. However, midterm gains of 54 seats in 1994 and 63 in 2010 gave Republicans a clearer political mandate and the votes to carry it out, at least in the House. By contrast, Republicans netted only 9 seats in the 2022 midterms and enter 2023 with a very thin House majority. Public focus on the public debt is also much lower compared to those prior periods, and Republicans have not emphasized fiscal restraint nearly as much recently as they had in the mid-1990s or early part of the Obama Administration.

Prior disruptive debt limit standoffs led to increased market volatility and a sell-off in Treasury securities maturing around the debt limit deadline, and we would expect this to occur next year. In 2023, we would expect yields on bills maturing around the deadline to rise by at least as much as they did in 2011 and 2013, and for volatility in financial markets to rise similar to those periods (Exhibit 14).

There is also a real chance that Congress fails to raise the debt limit in time next year, forcing Treasury to reduce daily payments to the level of receipts (i.e., immediately eliminating the budget deficit), resulting in a spending cut of around 10% of GDP at an annualized rate. While we think it is more likely that Congress manages to avoid this and raise the debt limit before it constrains Treasury’s ability to pay its obligations, the risk appears higher than at any point since 2011.

The deadline for Congress to raise the debt limit before Treasury must cut back net borrowing will likely be sometime in August but could be as late as October depending on Treasury cash flows (Exhibit 15). An early signal of the risk the debt limit poses will come at the start of 2023, when the new House of Representatives is seated. If Republicans reinstate the “motion to vacate” that allows any member of the House to call for a vote for a new speaker of the House—several Republican House members have recently called for this in return for their vote for speaker—it could be difficult for the next speaker to put a clean debt limit increase to a vote until forced by financial markets.

Quickly running through the other five questions (and answers) we have the following:

1. Will the jobs-workers gap fall below 3 million? – Yes
2. Will the job openings rate fall from its peak by more than the unemployment rate rises from its trough? – Yes
3. Will wage growth slow at least 1pp? – Yes
4. Will one-year Michigan consumer inflation expectations fall below 4%? – Yes
5. Will Congress enact substantial fiscal policy changes in 2023? – No.

For more detailed on these, and other questions and predictions, read the full note available to pro subs.

By David Finnerty, Bloomberg Markets Live reporter and analyst

Look for the dollar to have a good first quarter on the back of a hawkish Fed and deteriorating risk sentiment.

There are good reasons to expect the Fed to follow through on its hawkish dot plot given US core PCE data is proving to be sticky, and US employment data next week is forecast to show the labor market remains tight. China’s reopening has the potential to add to inflationary pressures if the surge in Covid cases spurs supply disruptions or via an increase in demand pressures.

Should the US central bank fulfill its hawkish predictions it would be a positive for the dollar as it would force investors to revise higher their expectations for the terminal rate, which are currently under 5%.

Deteriorating risk sentiment also tends to be a dollar positive. US equities are ending the year on the back foot which is an ominous sign for the start of 2023, particularly with earnings season fast approaching. Where US equities go other nation’s equities tend to follow. In addition, worries about a global slowdown aren’t going to help risk sentiment which is good news for dollar bulls.

Of course there are two sides to the dollar equation. How it performs will also depend on the euro, yen and sterling, which have large weightings in both the Bloomberg Dollar Spot Index and the Dollar Spot Index. Here though again there is reason to be optimistic for the dollar.

Both the euro’s and sterling’s rallies have stalled with them likely to come back under pressure in first quarter amid recession fears.

As for the yen, while the BOJ will more than likely amend its policy further next year, the summary of opinions to its December meeting signals that it may not be until after Gov. Kuroda leaves in April. That means US-Japan interest rate spreads should remain wide in the first quarter limiting the yen’s

The Kremlin has clarified its position on being ‘open’ to peace negotiations with Ukraine, after over the weekend Ukraine’s leadership floated a proposal to enter into UN-brokered ceasefire negotiations in February. 

Kremlin spokesman Dmitry Peskov on Wednesday said any future “peace plan” must involve formal recognition that the annexed eastern territories have joined the Russian Federation.

“There can be no peace plan for Ukraine that does not take into account today’s realities regarding Russian territory, with the entry of four regions into Russia. Plans that do not take these realities into account cannot be peaceful,” Peskov said.

Last week the Kremlin stated something similar, according to The Associated Press:

…no Ukrainian peace plan can succeed without taking into account “the realities of today that can’t be ignored” — a reference to Moscow’s demand that Ukraine recognize Russia’s sovereignty over the Crimean Peninsula, which was annexed in 2014, as well as other territorial gains.

Ukraine’s position has been to denounce the “sham” referendums Russia held in Kherson, Zaporizhzhia, and the breakaway Donbas republics of Donetsk and Luhansk (DPR and LPR), while vowing its forces will not stop fighting until every inch of Ukraine is “liberated”.

President Zelensky has even in the recent past said that Crimea must be returned from Russian control as well, and there’s been a handful of Ukrainian attacks on the Russian-held peninsula.

Both sides at this point see in the other’s position unrealistic demands. The Kremlin, for example, sees as a completely unserious non-starter the latest Ukraine assertion that the proposed February talks can only happen if Moscow agrees to a “war crimes tribunal” for its officials. This position will only become even more entrenched after Thursday’s massive Russian missile attack across Ukraine, reaching as far West as Lviv…

⚡️British Ambassador to Kyiv: The Russian attack on Ukraine today confirms that Moscow wants to subjugate Kyiv, not peace

— War Monitor (@WarMonitors) December 29, 2022

In addition to dismissing this “war crimes court” demand, the Russian foreign ministry has pointed to the greatly ramped up supply of weapons from Western countries, especially from the United States, which has derailed any legitimate move toward peaceful negotiations.

Fresh analysis in The New York Times says that at this point each side is still seeking a military solution, remaining hardened in their positions: 

As the battle for Ukraine turns into a bloody, mile-by-mile fight in numbing cold, Ukrainian and Russian officials have insisted that they are willing to discuss making peace.

But with a drumbeat of statements in recent days making clear that each side’s demands are flatly unacceptable to the other, there appears to be little hope for serious negotiations in the near future.

The Times then quotes the following analyst:

“This suggests there is not necessarily a push for a negotiated peace or even some sort of negotiations, but still a push for whatever endgame is being sought militarily,” said Marnie Howlett, a lecturer in Russian and Eastern European politics at the University of Oxford.

Lavrov this week said all of Russia’s objectives must be met… “Otherwise,” he said, “the Russian Army will deal with this issue.”

Interestingly, no less than former US Secretary of State Henry Kissinger penned an op-ed this month wherein he called for Ukraine and the West to get serious about territorial concessions in order for the war to end, with the ‘alternative’ being a continued spiral toward nuclear-armed direct confrontation between the US-NATO and Russia.