INFLATION - Why Everybody Gets It Wrong
How inflation blinds investors right before recessions.
Yesterday’s CPI print showed headline inflation at 2.7% and core inflation at 2.6%. Predictably, this has reignited the debate about whether inflation is “finally under control” — and what that means for markets and the economy. But this question misses the point entirely. Inflation is not a forward-looking signal. It is a late-cycle outcome. And by the time inflation is no longer the problem, the real problem — the business cycle itself — is already turning.
I’ve been writing about macroeconomics for long enough to notice a recurring pattern: whenever inflation spikes, the crowd fixates on it and assumes it’s a harbinger of more growth and boom times. Over the past two years, inflation has been the headline culprit – from fears of runaway prices to endless debates about “sticky” CPI. Yet here we stand at the end of 2025 with inflation back under 3%, and many analysts still don’t grasp what’s really happening. The irony is that inflation was never the true guide to where the economy was headed – it’s a lagging indicator, a rear-view mirror of the business cycle.
In this piece, I’m going to walk through past economic cycles to show why inflation often fools observers. I’ll explain how my Business Cycle Model has been signaling a slowdown since late 2024 – long before inflation relented – and how that slowdown is now being confirmed by a weakening labor market. I’ll also dive into the current liquidity surge (Treasury cash, Fed policy shifts, and a falling dollar) that’s giving markets a euphoric sugar high. Many investors are mistaking this for a new bull market, but I believe it’s the classic late-cycle blow-off – the last hurrah before a crash. By February or March 2026, I expect a full-blown recession to hit, and the Fed’s fight will not be against inflation at all, but against deflation. Let’s break down why “everybody gets it wrong” when it comes to inflation and the business cycle.
Inflation Is Always Late to the Party
Inflation tends to arrive fashionably late in economic cycles. By the time inflation is surging, the underlying economic momentum is usually already fading. This counterintuitive reality is why so many get it wrong: they see prices rising and assume the economy is still overheating, when in fact the peak has passed. History gives us plenty of examples. Think about the late 1980s, the early 2000s, or 2008 – inflation peaked after the growth engine had started sputtering. It’s only after a recession begins (or is imminent) that inflation comes crashing down. In other words, inflation is a lagging indicator of the business cycle, not a leading one.
Chart 1: Inflation (red line) versus the Fed Funds rate (blue line) across multiple cycles, with recessions highlighted in green. Notice how inflation peaks around the start of recessions (green areas) – or even after they begin. By the time inflation is making new highs, the Fed has often already hiked rates to restrictive levels, and an economic downturn is looming. In the current cycle, headline inflation is 2.7% (as of the latest print), down sharply from its peak – another sign we are late in the cycle.
Why does inflation behave this way? Demand drives inflation in the mid-cycle, but by late cycle that demand is waning even if prices haven’t gotten the memo yet. Businesses start to struggle with higher costs and interest rates, consumers pull back, but it takes time for those effects to filter into the price level. So inflation lingers, giving false comfort that things are still “hot.” Meanwhile, those watching only inflation are like a driver using the rear-view mirror to navigate forward – they’re bound to miss the turn.
I’ve long argued that one must watch leading and coincident indicators to know where we are headed. Inflation will always be the last to know. By the time inflation numbers confirm a trend, the real economy has moved on. This brings us to our current situation, and why back in late 2024 I was already warning that a slowdown was coming despite high inflation prints at that time.
The Business Cycle Model Warned Us Early
I rely on a proprietary Business Cycle Model that aggregates a range of forward-looking economic signals – everything from yield curves and liquidity measures to manufacturing new orders and housing data. By November 2024, virtually all the flags in this model were telling me the same story: the post-pandemic boom was exhausted and a slowdown was unfolding. At that point, inflation was still elevated and the consensus was convinced we were in a new era of persistent inflation. But the model said otherwise – it was essentially shouting that the business cycle was turning down.
What did I see back then? Leading indicators were rolling over. Consumer demand was softening, housing had cooled, and corporate earnings revisions were trending down. Crucially, money supply growth had stalled out and the yield curve was deeply inverted – classic harbingers of a downturn. In short, the conditions for a recession in the not-too-distant future were falling into place. I made that call in late 2024, trusting the model and the lessons of history.
Fast forward to today, and we’re finally seeing the evidence catch up. It took a year, but now even the most lagging parts of the economy are confirming the slowdown. Nowhere is this more evident than in the labor market – which, like inflation, tends to be a late-cycle indicator. Let’s look at what’s happening with jobs.
Labor Market: The Last Domino to Fall
The labor market is often the last domino to drop in the economic cycle. Employers are reluctant to shed workers until they absolutely must, so job growth usually stays positive until very late in the game. That’s why I’ve been laser-focused on employment data for confirmation of the slowdown – and it’s finally here. Several key labor indicators have weakened to levels we haven’t seen since the run-up to the Great Financial Crisis in 2007:
· ADP Private Employment (12-month average) – The average monthly gain in private payrolls over the last year is now running below the level we saw going into December 2007. In late 2007, ADP’s 12-month average job growth was around +76,000; today it’s only about +61,000. Considering the U.S. labor force is larger now, this slowdown is even more pronounced than it was back then.
· Non-Farm Payrolls (12-month average) – The official non-farm payroll (NFP) growth has slowed to roughly equal the pace of late 2007. The economy is adding on the order of ~70,000 jobs per month on average over the past year, which is essentially the same anemic pace we saw at the end of 2007, right before the recession hit. Recent monthly NFP reports have been shockingly weak – we even had an initial print of -105,000 for October.
· Coincident Index (COI) – My composite Coincident Index, which tracks broad economic activity in real-time, has now touched the equilibrium line (0% growth). This means the economy has essentially ground to a halt. In past cycles, once the COI goes flat or negative, a recession is either underway or mere weeks away.
