For much of the last 12 months, attention has been focused on the Federal Reserve and its fight against inflation. In that time, the annualized pace of inflation has slowed significantly from a forty-year high of 9.1% on headline CPI (Consumer Price Index) in June of 2022 to 3.0% in June of this year. Meanwhile, the growth rate of Core CPI has declined from a peak of 6.6% in September 2022 to 4.8%. The significant decline in the rate of inflation was largely due to the Federal Reserve’s aggressive action to raise interest rates at an unprecedented pace. Nevertheless, the current levels are still well above the Federal Reserve’s preferred threshold for healthy economic growth. We believe that given the still elevated level of inflation, the Fed will likely maintain a restrictive policy stance with an aim to get inflation lower. While the Fed declined to increase the benchmark Fed Funds Rate at their June meeting, we anticipate another 1-3 rate hikes from the Fed this year and anticipate their continuing fight against inflation will take the form of maintaining rates at elevated levels for an extended period of time.
Raising rates slows borrowing and, ultimately, the pace of the economy, which should eventually translate to lower inflation. However, the risk of slowing the economy is that it may hit a stall, otherwise known as a recession. For some time now, we have been anticipating a slowdown in economic activity and have viewed the resilience of economic growth as a positive surprise. Despite the fastest pace of rate hikes in the history of the Fed, we have seen positive growth over the past three quarters, and the GDPNow estimate for second quarter 2023 anticipates that the economy grew at an annualized rate of 2.3%, illustrating the resilience of the economy. Further evidence of this surprising economic strength can be seen in the large number of jobs we continue to add to the economy (209,0000 in June) and the low unemployment rate (3.6%). Despite the backward-looking numbers showing how strong the economy has been, we maintain a cautious view of future growth. The Federal Reserve projections for the remainder of the year indicate a slowdown on the horizon, as revealed in their summary of economic projections, which show unemployment rising late in the year.
Additional economic indicators we follow also paint a mixed picture of the economy. The Producer Price Index (PPI), which can be an early indicator of the direction of consumer prices in the future, has continued to trend downward, the most recent retail sales data (May) showed an uptick in activity, and the National Financial Conditions Index (NFCI) has begun to show signs of tightening. We have also seen sentiment indicators like the University of Michigan Consumer Sentiment Index showing that consumers are concerned about the economy. Although consumers are not yet slowing their consumption, the Conference Board’s Leading Economic Indicators Index is still signaling a recession within 6-18 months. All of which adds up to a very muddled picture and one in which we are maintaining a cautious stance.
As always, we continue to monitor economic data for additional signs of a slowdown and incorporate the macroeconomic signals into our portfolio decisions. While evidence of economic headwinds continues to mount, we continue to believe there is enough resilience in consumer finances to limit the depth of any downturn that may occur.
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