A Macro Update

The Fed meets again this week, and is expected to issue another 25bp hike to the federal funds rate. This is potentially the last rate increase of this tightening cycle, though the more relevant issue may be how long the Fed maintains its higher rates. Recent macroeconomic data suggest that the economy has slowed but that inflation, while down from its peak, remains too high and surprisingly sticky. A wait and see approach may suit the Fed as it can see whether the cooling economy reduces inflationary pressures.

GDP growth was only 1.1% in the first quarter of 2023, which was below expectations of 2% from economists responding to a Dow Jones survey. GDP rose by 2.6% in the fourth quarter of 2022 and 2.1% overall last year, so we may finally be starting to see a more significant impact from the Fed’s many rate increases over the past year. However, the Commerce Department also reported personal consumption expenditure (PCE) inflation as 4.2%, which was higher than expectations of 3.7%. Core PCE inflation that excludes more volatile food and energy prices was even higher, at 4.9%.

Unemployment remains low, at 3.5%, and wages continue to grow fairly rapidly. The Employment Cost Index rose 1.2% in Q1 2023 after increasing 1.1% in Q4 2022. On a year over year basis labor costs increased 4.8%. These numbers suggest a tight labor market and continued core inflationary pressures. 

Overall, inflation is around 4%-5%, which is well above the Fed’s 2% target. Credit tightening in response to Silicon Valley Bank’s failure should be a drag on the economy, as should elevated interest rates. The impact of the Fed’s 4.75% rate hike over the past 14 months may finally be showing up in GDP data, but its ultimate effect on labor markets and inflation remains to be seen. The ideal case of normalizing inflation without a recession appears increasingly unlikely, but the possible outcomes of a recession are also quite broad, ranging from stagflation (recession plus high inflation) to a mild recession accompanied by a significant decline in inflation. The Fed is wisely keeping its options open, given the sheer number of moving parts in the economy.

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This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument or investment strategy. This material has been prepared for informational purposes only, and is not intended to be or interpreted as a recommendation. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice.