November 1, 2022

     

    

After two consecutive quarters of negative growth the U.S. economy expanded at an annualized rate of 2.6 % in the third quarter. The economy has been resilient thus far, but recent indicators have been mixed, perhaps signaling some loss of momentum and slower growth ahead. According to a survey of economists by the Wall Street Journal the U.S. is forecast to enter a recession in the coming 12 months as the Federal Reserve battles to bring down persistently high inflation, causing the economy to contract and employers to cut jobs in response. 

  GDP vs Inidial Jobless Claims     

      The Fed sees inflation as the greater evil, realizing some “pain” will occur as it does “whatever it takes” to bring inflation back toward its 2% target. With that, recession risks are rising. However, with no significant relief to inflation yet, the FOMC is expected to raise interest rates by 75 basis points for a fourth consecutive time at the November 2nd meeting. Recent comments by Federal Reserve Vice Chairperson Lael Brainard suggest communications about Fed’s rate path may be in transition. Brainard noted it is important for the central bank to pause at some point to assess the damage that previous policy actions are having on economic activity as monetary policy affects the economy with long and variable lags. Additionally, San Francisco Fed President Mary Daly said she wants “to make sure we don’t over-tighten, just as much I want to make sure we don’t under-tighten.” On October 21st, a Wall Street Journal article reported Fed members “are likely to debate then (the November FOMC meeting) whether and how to signal plans to approve a smaller increase in December following a 75 basis point November hike.” In sum, there is a growing concern among some of the Fed officials of breaking the economy and disrupting financial conditions.

Housing Markets
   
    

The Federal Reserve’s Beige Book said the U.S. economy grew “modestly” through early October, but performances were mixed in different parts of the county. Housing activity continues to weaken. The spike in mortgage rates has deteriorated home buying affordability and reduces the pool of potential buyers. High inflation and rising interest rates are beginning to force consumers to be more discerning with their purchases.  Consumer spending is softening as households tighten their purse strings. Businesses continue to hire at a strong clip, but growth has been a touch more subdued. In the meantime an imbalance between job openings and available workers remains. But going forward, firms will need to balance headcount with rising costs and slowing demand, allowing the labor market to moderate in the months ahead.


CPI Goods and Services

    
   

The September Consumer Price Index (CPI) report showed that consumer inflation remains stubborn at the headline and core levels. Supply chains functioning more smoothly and a downdraught in many commodity prices due to demand concerns appear to be easing price pressures for goods. On the other hand, inflation pressures continue to broaden and services inflation continues to trend higher. Service inflation is likely to remain stubbornly high in the months ahead, keeping headline inflation sticky and suggesting there remains a long way to go before it returns to target.


Stocks vs 10 Yr T Note

        

Financial markets have become volatile, raising some questions about the outlook for Fed policy after the November FOMC meeting. Uncertainty and cross currents are starting to put global financial stability risks front and center. The Fed, however, will not be willing to give up their commitment to bring inflation back to their 2% goal. Given that and signs that the global economy is slowing, some hints that the drivers behind the surge in global inflation may be easing and a need to not impair market functioning, the FOMC may start talking about a downshift in the pace of tightening from 75 basis point per meeting to 50 or even less once past the November meeting. The Fed will remain dependent on incoming data, prioritizing their fight against inflation, while still trying to exercise care not to crash the economy or financial markets.