Economics and Strategy
A Fed More Comfortable With Economic Pain, Setting the Table for a Late ’23 Recession
Chief Economist Aneta Markowska says the US Federal Reserve needs to see below-trend GDP growth if it has any chance of returning to 2% inflation. But she believes growth is on track to accelerate sharply in 2H to a 2.6-3.2% range. Household balance sheets are too strong, nominal income is too strong, and now, declining energy prices are boosting consumers' purchasing power, which is likely to increase demand for non-energy goods and services at a time when the Fed is trying to push it down. As a result, the Fed has shifted to becoming unambiguously hawkish, and while their new projections stopped short of forecasting a recession, they seem to suggest a greater tolerance for economic pain. Aneta continues to project that a combination of higher rates and a stronger dollar will cause the economy to slide into a recession in 2H23, and she believes the risks remain skewed to the upside for short term rates.
Chief Market Strategist David Zervos believes the markets are still in the process of digesting the Fed’s current policy stance. While he expected that equities would have a tough time this year handling higher rates and quantitative tightening, he believes market participants know the current pain is necessary for a brighter future. In addition: 1) with nominal income growth remaining so strong, it was hard to see nominal earnings coming down drastically; 2) aggressive Fed hawkishness is leading to increased credibility and 3) the market has already priced in a lot of negativity. Nonetheless, bottom picking is typically messy business, and David remains cautiously positioned within his trading recommendations.
Global Head of Equity Strategy Christopher Wood continues to believe global CPI reports will remain the most important monthly data point, especially now that inflation is becoming entrenched in the services sector. On the other hand, though central banks remain hawkish, he also notes that there have been some small crumbs of comfort for those looking for a sign that inflation has peaked. Aside from the data itself, Christopher believes the key issue remains whether the political pressures on the Fed to change following the US midterm elections in November. For now, the situation remains the inverse of Goldilocks with recession risks growing every time the Fed tightens. He continues to prefer value over growth, but expects the critical issue to increasingly be not whether a stock is “value” or “growth” but whether it generates cash and pays a dividend.
Global Equity Strategist Sean Darby notes that global equities were range bound through the past quarter as higher US yields and a strong dollar capped the upside. Meanwhile inflows by income seeking investors put a floor on share prices helped also by the perception of strong balance sheets. There were no signs of panic. Indeed, positioning is quite bearish going into Q4, suggesting that as inflation pressures abate, there is room for equities to re-rate, particularly if commodity prices moderate.