Market Update January 2023 – Recession: Is the sure thing for sure?!?

CAPITAL MARKETS

As we move into the new year, investor’s priorities are likely: 1) Federal Reserve (Fed) interest rate policy, 2) Inflation, 3) Fed interest rate policy, 4) Corporate Earnings, 5) Fed interest rate policy, and so on.  History suggests that the risks of high levels of inflation can choke off economic growth, potentially leading to a recession and, as the keepers of monetary policy, the Fed is keenly aware of the risks.  In recent history, inflation, as measured by the Consumer Price index (CPI), had ranged from just below zero in 2015 to 2.9% in mid-2018 on annualized basis.  But following the introduction of post-COVID policies, CPI shot up quickly to an annualized peak of 9.1% in June 2022.  The Fed recognized this trend and pivoted to combat these rising price pressures, primarily by raising interest rates with the expectation of slowing down economic activity and tamping down inflation.

Now the tricky part.  Fed policy takes time to work.  And history suggests that the Fed will maintain current policies longer than beneficial by keeping interest rates higher than necessary and, raising the odds of a recession.  There may not be much these days that is generally agreed upon amongst the U.S. population, but avoiding an economic recession is likely one.  And as we enter 2023, evidence is mounting for a shift in policy towards smaller rate hikes and/or a slowing pace.  But recent comments from Fed officials appear to be contrary.

From Bloomberg news:

“Fed Officials See Further Rate Hikes Before Holding Above 5%” 1/9/23
Two Federal Reserve officials said Monday that the central bank will likely need to raise interest rates above 5% before pausing and holding for some time. “We are just going to have to hold our resolve,” Raphael Bostic, president of the Atlanta Fed, told the Atlanta Rotary Club. He said the Fed was committed to tackling high inflation and this warrants raising interest rates into a 5% to 5.25% range to squeeze excess demand out of the economy…  Asked by the moderator how long he saw rates above 5%, Bostic said: “Three words: a long time.” and “I am not a pivot guy. I think we should pause and hold there, and let the policy work,” he said.

The tension between controlling inflation while  avoiding a recession complicates the difficult feat of a “soft landing” and these comments sound consistent with the Fed’s well-intentioned, yet very rigid plans. ,

While the recession rhetoric continues to ramp up, it remains to be seen how this era’s unique combination of economic characteristics may play out.  For much of the last 20+ years, Fed policy has focused on reviving a faltering economy during recessionary periods.  Today, the Fed faces the opposite in the challenge of a strong economy and it stands to reason that this would require a different approach.  And raising interest rates has been the primary tool of choice.  The practice is not to be feared, but knowing when to back off will determine success.

CHARTS OF INTEREST

The two charts below, and their accompanying comments, address these considerations which, in tandem, support the idea of a soft landing.  Does it sound like the fatal words “this time its different”?  Maybe, but each economic era has its hallmark characteristics.  And the current era is shaping up to be less like that of this century and more akin to the late-1980’s and 1990’s which, by the way, experienced the mythological “soft landing” in 1994.  Let’s hope the Fed pulls the right playbook off the shelf.

Inflation Losing Momentum — Nowcasts

  • Ahead of the December CPI print, Bloomberg Economics’ new nowcast model is pointing to a further deceleration in US inflation:
  • Our nowcast predicts a December CPI reading of 6.5% year over year, down from 7.1% in November. That is in line with consensus, and slightly below the 6.6% anticipated by the Cleveland Fed’s model.
  • Bloomberg Economics’ US team forecast — which relies on a bottom-up process — sees a larger drop to 6.3%, driven by weaker commodity prices, inventory clearances, and a downturn in sectors hit hard by Fed tightening.
  • The nowcast reading largely reflects negative momentum in the CPI series itself, as well as smaller contributions from energy and import prices. The model also suggests a further deceleration for January 2023, to 6.1%.
  • Source: 01/11/2023 06:00:10 [BI] Bloomberg Intelligence, US INSIGHT: Nowcast Flags CPI Drop to 6.5%, Bigger Fall Possible, By Andrej Sokol (Economist) and Björn van Roye (Economist)

US Households’ Cash Hoard Could Buoy Corporate Profits: Chart

Source: Bloomberg Intelligence

  • US households are flush with cash despite rampant inflation, suggesting that fears of a coming consumer meltdown may be unwarranted. Even with the saving rate at all-time lows, the bulk of consumers’ balance-sheet assets are still growing and overall debt remains at near-record lows, giving them plenty of buffer for higher interest rates, Bloomberg Intelligence strategist Gina Martin Adams and associate Gillian Wolff said in a note Tuesday. That indicates a light earnings recession in 2023 is much more likely than a 2008-like crisis, they said.
  • Source: 01/03/2023 09:38:09 [BN] Bloomberg News

 

JAMES FERRIN
Chief Investment Officer

 

 

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