Economic Note: The Fed Buys into the Soft Landing Narrative
We remain at an interesting point in the economy and economic narratives. The economy continues to evade expectations for a recession with continued resilience across a number of data points (GDP, employment, inflation). Meanwhile, much focus remains on the Fed’s every move, which maintains a sense of uncertainty. Here are a few observations on the economy:
Investor sentiment has remained upbeat throughout 2023. Financial markets have rebounded from their 2022 sell-off, with the S&P 500 gaining more than 15% and credit spreads tightening. The Fed's tightening cycle is nearing an end, and its impact has been limited thus far compared to prior tightening cycles. The U.S. consumer continues to be supported by low unemployment and wage growth, and while data shows the rate of economic activity is slowing, it remains positive despite the aggressive rate hike cycle. GDP growth has exceeded expectations, housing activity is rebounding despite elevated mortgage rates, and the industrial sector remains resilient as the government invests in infrastructure upgrades, renewable energy, and semiconductor production.
Throughout the tightening cycle, the Fed has refrained from making big changes to its forecast. Instead, it has consistently revised its outlook in response to hard data releases, such as job growth, unemployment, GDP growth, etc. What are the Fed's latest views? Based on the Summary of Economic Projections (SEP), you can add the Fed to the list of soft landing optimists. The following is a list of the major changes in the Fed's SEP since it was last updated in June:
●The fed funds rate is now projected to end 2024 at 5.1%, up from the 4.6% estimate in June. With the increase, the Fed removed 0.50% of expected rate cuts in 2024. The increase is the Fed's way of communicating its 'higher for longer' view and warning the market that rates will have to remain restrictive for the foreseeable future. The market received the message, with the 10-year Treasury yield rising to 4.5%. The forecast for higher interest rates is quickly becoming a crowded trade, and as history has shown, crowded trades rarely play out as expected. From a positioning point of view, we continue to like long-duration bonds in the portfolio.
●The Fed revised its 2023 and 2024 GDP estimates higher. The 2023 estimate was revised from 1%to 2.1%, and the 2024 estimate was revised from 1.1% to 1.5%. It's an acknowledgement from the Fed that the economy remained resilient in 1H 2023 despite higher rates.
●The most notable revision relates to a change in the forecasted unemployment rate. The Fed now expects unemployment to peak at 4.1%, down from its estimate of 4.5% in June. However, it's extremely difficult to manage unemployment, which is a lagging indicator, and we don't expect this cycle to be different.
Our recommendation is to stay disciplined. The economy continues to show resilience while bouts of volatility signal investor anxiousness over the possibilities of prolonged higher interest rates or recession. We remain optimistic about the future but fully expect volatility to occur along the way. We continue to emphasize fundamentals along with diversification into uncorrelated assets and discipline will remain our cornerstone.
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