August 1, 2022

     

     The Federal Reserve is raising rates, the economy has lost momentum and recession talk has reached a crescendo. The first estimate of real GDP for the quarter ending June 30 registered a -0.9% annualized quarterly rate. This follows a -1.6% contraction in the first quarter, meeting the textbook “technical” definition of recession of two consecutive quarters of negative GDP. The National Bureau of Economic Research (NBER), however, has the final official say. Weighing on the NBER’s pronouncement is nominal GDP, or non-deflated GDP, which showed strong positive numbers in the first half of the year. While the Fed is seemingly stuck between a rock and a hard place, the central bank officials believe that first and foremost they must restore price stability. Thus, more rate hikes are on the way.

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      Following a rate hike of 75 basis points at the June meeting, the FOMC elected to continue their aggressive stance at the July 26-27 meeting with another increase in the fed funds range of 75 basis points to 2.25% - 2.50%. Inflation remains forefront in the minds of most FOMC members as Consumer Price Index (CPI) inflation jumped by 9.1% year-over-year in June, up from 8.6% in May. The Fed believes cooling aggregate demand with higher interest rates is needed to subdue the pace of economic growth. Subdued growth, in combination with some easing in supply constraints, should dampen price pressures bringing down inflation. The Fed needs to see “clear and convincing evidence that inflation pressures are abating and inflation is coming down” before ending the tightening of monetary policy.


Borrowing Savings   

     The persistence of inflation weighing on business and consumer outlooks and the Fed moving from floor boarding the accelerator in 2020 and 2021, to slamming on the brakes in 2022 has increased the odds, and fueled fears, of a recession. Financial markets as a forward discounting mechanism foreshadow challenges to the economic expansion, and the Treasury yield curve is sending such a signal. Inversion of the curve in which longer term rates are below those on shorter dated maturities has preceded every recession. The inversion is driven by the market pricing the Fed’s monetary path in the short-end, while downside growth risks weigh on yields at the back end of the curve.

GDP and Employ

   
In addition to the yield curve experiencing inversion and commodity prices falling recent weeks due to demand concerns, recession talk has gained traction as signals of an economic slowdown have mounted. Hiring remained solid in June, adding 372k jobs, well above the consensus forecast, but an increasing number of layoff announcements, hiring freezes and rising initial filings for unemployment benefits suggest employment is likely headed to a lower plane. The Institute of Supply Management (ISM) manufacturing and services survey remained above 50, in June signaling expansion continued, but the S & P Global Group preliminary July service Purchasing Managers Index (PMI) dropped sharply, suggesting contracting activity. The housing market has stalled and measures of consumer activity and confidence have softened on higher prices and deterioration of prospects. Clearly the economy is slowing from its previous pace, but signals vary as to the magnitude of decline and what the future may hold.


Lumber Futures
   
 Although a recession is not a desired outcome for the Fed, failing to gain control of runaway inflation could have greater adverse consequences for the economy. The path of monetary policy is being driven almost entirely by inflation. In his post FOMC meeting press conference Fed Chairman Powell reiterated restoring price stability is something the Fed has to do. With the 225 basis points of tightening in just over 5 months, the lagging effect of monetary policy adjustments suggests there is significant tightening in the pipeline whose effects have not yet been fully felt. While not eliminating another large increase in the fed funds range if needed, Powell commented it could likely be appropriate to slow the pace of increases. Such moves would be on a meeting-to-meeting basis and dependent on data, he emphasized, forgoing more specific forward guidance due to the unusually high level of economic uncertainty