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The End is Near

The End is Near

| July 26, 2023

The phrase "The End is Near" is fraught with apocalyptic overtones, but when referring to the Federal Reserve's interest rate hiking effort, it spells potential relief.  Today, we are likely to learn that the Fed continued its monetary tightening program by raising its benchmark interest rate by another quarter of a point.  But many economists believe that we are near the end of the tightening cycle.

Inflation has surely cooled from its highs of last year.  Recall that inflation was fueled by a shift in consumer spending from services to goods during the pandemic, causing prices of those goods to push higher.  Bottlenecks ensued in supply chains as companies found themselves unable to meet demand. The war in Ukraine exacerbated inflationary trends in energy and food.

Many of these issues have improved, and supply chains have been deregulated in some cases to improve flexibility.  The impact of higher interest rates, slower economic activity, and improved supply chains has been falling prices for everyday goods such as new and used cars, many food commodities, and even home prices and rents (although housing supply shortages still are the major driver of prices in many metro areas.) 

The International Monetary Fund echoes this assessment, stating that some general commodity categories have declined precipitously of the past 12 months:  Fuel Index -45%, Metals Index-12.5%, Food Index -15%

The bottom line is that the Fed sees that inflation has cooled, but it has not yet approached the their 2% target, so tightening continues.  Fortunately, unemployment rates have not risen, and consumer spending, while off of peak levels, remains robust.  Such conditions have caused market participants to increasingly believe the the Fed will indeed "nail the landing", as we wrote about earlier in the year.  A slowdown without recession is a positive outcome, and rebounding stock prices reflect that optimism.

Could the economy slip into recession despite these signals?  Of course.  Monetary policy has notoriously long lag times, so rate increases six months ago are still working their way through the economy.  Today's rate hikes can still do damage months from now, but one can't really predict this with even a modest level of certainty.  After all, wasn't pretty much everyone calling for a recession just a few months ago?

What we do know is that companies are resilient, and portfolios of companies are even more so.  So, we'll leave the recession handwringing to others and note that those who stayed the course through the pessimism have again outsmarted the experts.  In our mind, the bigger short term risk is that overbought markets leave stocks vulnerable to a correction.  That wouldn't be a surprise, and consolidation after a rebound is both normal and healthy.