Inflation has started to increase in “stickier” areas, meaning bottlenecks have not yet begun to clear. Lower income households are now experiencing double-digit inflation for over 50% of their typical expenditures with housing, food, and energy costs continuing to rise. Consumer demand for certain items is starting to decline for discretionary items. Wages will need to continue to rise for companies to pass through price increases.
From the Fed’s December to February meetings, expectations went from three to seven possible rate hikes in 2022, and they have since continued to increase this spring. This has led investors to reprice the stock market based on a much more aggressive Fed than anticipated. Expectations have just begun to slow down as some inflation data appears to be rolling over. The Fed’s aggressive pivot and the market pricing in double digit rate hikes have led bonds to the largest intra-year decline on record.
The Leading Economic Index looks at trends in leading economic datapoints such as employment, manufacturing, and financial conditions. A persistent decline in this index has historically been a potential leading indicator of recessions. We have had four negative consecutive monthly LEI readings (April-July).
Often, when it comes to the relationship between economic data and the stock market, better or worse matters more than good or bad; or, in other words, trends and direction are more important than levels.
The table illustrates that even though the levels of most indicators are strong or fair, the trends are less optimistic.
This hasn’t led to a material deterioration in the overall index, but if the trend column turns increasingly yellow and red, levels would inevitably follow the same pattern.
Historically, the U.S. economy has not gone into a recession without labor market weakness. The Fed’s plan for additional rate hikes plus quantitative tightening (QT) in the next several meetings still looks intact. From here (at full employment) job growth should be slowing.
If people stay employed, that means consumers are receiving paychecks, have cash to spend, and the U.S. consumer drives about 70% of U.S. GDP. That’s one of the main factors that is supporting the economy as recessions risks are rising.