At Harford Financial Group, our investment committee is constantly monitoring the economy and financial markets. Over the last two years or so, the prevailing theme has been inflation and how the Federal Reserve is using interest rates to combat inflation. The purpose of this article is to provide an update on where inflation and interest rates stand today, as well as discuss the likelihood of recession in the U.S. according to various asset managers.
Headline inflation has continued to fall from last June’s 40-year high of 9.1%. The consumer price index, which measures inflation, increased 3% from a year ago, which is the lowest level since March 2021. This is good news and shows the Federal Reserve’s strategy of raising interest rates is working. The graphic below shows how inflation has come down over time – particularly in Energy and Core Goods. However, we are not out of the woods yet. Inflation in core services – particularly shelter (housing and rent) – has proven to be more persistent than expected. Changes in shelter prices typically lag other components of the inflation measurement largely due to the nature of lease contracts, which often renew annually. This lagged effect may keep headline inflation numbers above the Federal Reserve’s 2% target throughout 2023.
The federal funds rate, or Fed rate, is currently 5.25%. This is the interest rate that U.S. banks pay one another to borrow or loan money overnight. It also affects interest rates on everyday consumer products, such as credit cards or mortgages. The Federal Reserve has been raising the Fed rate to combat inflation. We saw significant rate hikes throughout 2022 but the pace of rate increases is moderating as inflation comes down. The market is anticipating 1-2 more rate hikes in 2023. As the Fed starts to approach a pause in the hiking cycle, the market narrative is changing from one of uncertainty about inflation and peak rates to questions about how the US economy will absorb higher interest rates throughout the rest of 2023 into 2024.
The chart below shows three potential outcomes for the U.S. economy in 2023, and what each could potentially mean for various segments of both the economy and markets. The term “landing” is frequently used when discussing whether an economy will enter a recession at the conclusion of rate hiking cycles. By raising rates, central banks seek to slow the economy to bring price stability while avoiding a recession. After beginning the year cautiously optimistic about the prospects of a soft landing, market sentiment shifted quite a bit throughout the first quarter, pricing in both a no landing and hard landing outcome. While it remains to be seen what’s next for the U.S. economy, strength in both the labor market and consumer indicate that a soft landing still may be possible.
It is good to stay current on what is happening in the economy and financial markets. But more important is to have a plan to fit your own specific goals and needs and stick to it through various market conditions. If you have any questions or concerns, please reach out to your financial advisor. We are here to help.