The weight of evidence does not support an imminent recession. Rather, it appears thus far the Federal Reserve is successfully slowing down the economy slightly without driving it into a period of sustained economic contraction.
The inflation rate reached a forty-year high in March, indicating an 8.6% increase in the Consumer Price Index over the prior twelve months. We believe that this peak will not be exceeded and that inflation could retreat faster than widely expected.
Only a few months into the Federal Reserve raising interest rates, a general slacking in demand is becoming evident. For example, both Target and Walmart recently reported rising inventories of non-essential goods and noted increasing difficulty of passing price increases onto consumers. Existing home sales have also fallen since January as higher mortgage rates priced out many potential homebuyers. Finally, some big-tech companies (like Amazon) are starting to report excess capacity, suggesting that they may be able to adequately meet consumer demand even with gummed up supply chains.
This demand shrinkage is exactly what the Federal Reserve is trying to accomplish to tame inflation. We would argue their policies are working and likely faster than most expected. Therefore, we expect year-over-year “core inflation” (excludes food and energy) to fall to below 3.50% (its most recent peak was 6.43%) by the end of this year. A risk to this outlook would be a further escalation of the Russia/Ukraine conflict, which could cause further energy shortages and diminish the Fed’s efforts to bring inflation down.
On Interest Rates
Piggybacking on the comments above, investors are currently expecting at least five more 0.50% increases in the federal funds rate through year-end. Lower inflation over the near term would reduce the need to continue hiking interest rates. Therefore, we believe only two interest rate hikes will occur before the Federal Reserve reassesses and pauses its rate hiking.