The Market Moves on From Inflation Anxiety to Recession Fear
Curbing demand without triggering a recession defines a soft landing that the Fed is attempting to craft for the economy. They’ve been successful in only one of 11 attempts in the modern era (1994), so the odds are long. The FOMC has employed all of its tools since March in seeking to strike a balance between supply and demand and restore price stability. Foremost among those tools is raising the Fed Funds Rate back to what is viewed arbitrarily as “normal”. Year-to-date, rate hikes have taken that key rate from a range of .25%-.50% up to the current 2.25%-2.50%. The Fed actions in March, May, and June were surrounded by significant selling in the stock market. The latest rate hike of .75bp offered a brief respite from that trend by triggering a summer rally. We think that rally, its end in mid-August, and the current sharp selloff points to the market moving on from inflation worries to fears of almost-certain recession.
We’re among those that are seeing a peak in inflation that has yet to be fully confirmed by the data. That’s not unusual since the effects of tightening credit and reducing the money supply don’t impact all components of the economy at the same time and in a linear manner. We’ve seen housing, commodity, and gasoline prices peak, but the market still awaits evidence of a broader effect from tightening. This week, August YoY CPI came in at 8.3%, lower than July but higher than estimates. Core CPI (excludes food and energy) rose more than estimates on higher prices for healthcare, furnishings, autos, and rent. Wholesale prices (PPI) declined year over year but wage pressure is building. Recent manufacturing data is improving along with employment. This mixed bag of results is indicative of the distortion, at any given moment, among datapoints flowing from the economy as it’s impacted by the Fed’s actions. While recession is a possible and plausible outcome, the longer-term picture of the economy isn’t fully developed yet.
It will take the rest of the year to see the full effect of rate hikes. Lost in the current narrative is the added impact of the Fed balance sheet runoff that hit full speed this month. Recession fears revolve around what the Fed will do through year-end. The Fed meets next on September 20-21st. Many expect this week’s data to prompt the board to engage a third consecutive .75bp rate bump. While that would raise the probability of recession, it brings us much closer to a pause that will precede any future pivot in rate adjustments. We’re among those hoping for the unlikely tapering of an adjustment by the Fed to .25bp or .50bp. That would allow more time for the totality of data to catch up with the real-time impact of tightening on the economy. This could ease recession fears and any unease surrounding the earnings results we’ll see in early Q4. Stay tuned.
Feel free to send a private message or make comments securely through our contact us page.