Looking Toward the Beginning of the Next Cycle
What happened last week?
- The S&P 500 gained 0.69%
- The Dow Jones advanced 2.08%
- The Nasdaq composite shed -0.57%
The Fed is widely expected to raise rates by 25 basis points this Wednesday on the grounds that inflation is still too high.
If they do it will bring the Fed Funds rates to its highest level in 22 years.
3 Things to Know
A shift in investor sentiment
Did anyone expect that global equities would be up 17% year-to-date while short-term Treasuries were offering rich yields? We didn’t. So, how did we get here and what’s different now than what we expected?
As we entered 2023, equity and debt markets had come off their worst combined performance since 1931. There were only two previous years of combined US stock and bond market declines in the past century.
Investors had nowhere to hide. Diversification across asset classes vanished and the inverted yield curve signaled a material V-shaped recession was ahead. With the unanimity of pessimism, investor positioning in equity markets was more bearish than in any other period we can measure.
Markets last year had priced in a lot of bad news heading into 2023. Given the Fed’s extraordinary rise in rates, the likelihood of a recession was high as we entered 2023.
High interest rates, asset price declines, strained budgets, more savings and less investment, persistent inflation and geopolitical tensions pointed to an economic contraction.
Sustained period of slow growth
The US and world economies appear to be contracting and growing in different places at the same time.
Significant parts of the world economy and particular industries that were expected to have a recession are, in fact, in recession. There is booming demand for travel this summer, even as there are recessionary conditions in manufacturing and housing.
The offsetting contraction and growth of sectors within the economy reflect a below-trend 1.5% year/year GDP growth in the year through 2Q, above CGWI’s prior estimates for about 1% growth. CGWI expects tepid growth to continue in the US in 2024.
However, this sustained period of slow growth is compelling evidence of a rolling recession.
Inflation is way down
A significant source of recent market optimism comes from a major drop in inflation.
Not only have headline US consumer prices slowed to 3% from a peak of 9% a year ago, but the most troubling components of core inflation are moderating in a similar way.
US services inflation, excluding housing, has slowed from an 8% pace to about 3%, as well.
The drop in headline inflation is boosting US consumer confidence and real incomes. And disinflation is very likely to be global.
The end of the post-Covid spending boom in services is likely to be a larger contributor to disinflation than many anticipate.
Finally, the known long lag between housing developments and measures of shelter price inflation suggests a sharp slowing in the US core CPI in the year to come.
See our weekly CIO Strategy Bulletin for more details