Forecasting regime shifts are difficult for both public policymakers and private investors. The macro environment will likely experience a shift in the coming months as consumers retrench and businesses slow hiring. Despite emerging signs of slowing, the Federal Reserve (Fed) recently communicated a hawkish stance on the path of interest rates going forward and the markets seemed to take it all in stride.
At the conclusion of the June 13-14 meeting, the Federal Open Market Committee (FOMC) kept rates unchanged but communicated a hawkish bias toward future interest rate decisions. Committee members were intent on further tightening but expressed concerns over unknown risks yet to emerge from the cumulative tightening over the past year. During the post-meeting press conference, Fed Chairman Jerome Powell indicated the Committee has not made a decision about next month, but if economic conditions hold steady, investors should pencil in a 0.25% increase to the fed funds rate. Along with the statement, the Committee updated the Summary of Economic Projections (SEP), which is arguably more important than the brief monetary policy statement. Within the most recent SEP, most policymakers believe further tightening is needed unless conditions materially weaken.

 Inflation Is Going in The Right Direction

We think the Fed should consider the improving inflation outlook in addition to the other variables and concerns they’ve already stated. The latest Consumer Price Index (CPI) print decelerated toward the lower end of expectations, with overall headline inflation falling to the lowest level since April 2021. The encouraging trend in consumer prices will provide the Fed some leeway throughout the balance of 2023. Investors seem to believe the latest CPI report shows inflation is heading in the right direction and likely reinforced the Fed’s decision to skip a June rate hike or even pause for a longer period.

A Lot Can Change in A Few Quarters

So, why bring up a Fed statement from 2007? Because it’s a good example of how radically the economy can change in just a few quarters. In the January 2007 statement, the Fed communicated a “hawkish pause” because they anticipated a stabilizing housing market, a growing economy, and nagging inflation risks. A lot changed over the course of 2007 and 2008 as the economy fell into the Great Financial Crisis. The current SEP revised up GDP growth forecasts and softened the deterioration in unemployment, and it seems the Fed is reticent to forecast a recession. However, our most likely scenarios put the economy in a mild recession by the end of the year as consumers retrench and businesses slow hiring as surveys suggest.

Periods of economic regime shifts are difficult for policymakers to manage. This current environment could be eerily similar to early 2007, when the Fed held a tightening bias on rates as they believed the housing market was stabilizing, the economy would continue to expand, and inflation risks remained. Both the January 2007 statement and the most recent one last week specifically mention the FOMC’s process in determining the extent of additional policy firming that may be needed. Clearly, those expectations were not met since we know what happened in later quarters. Despite the reference to 2007, our baseline is the economic slowdown does not produce another “2008,” yet investors should anticipate some volatility as the economic outlook remains cloudy. Feel free to contact Elise or I with any questions and let us know if you have a friend or relative who would like to be on this newsletter list. -Mark and Elise

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