INSIGHTS

On September 25, 2023

AAM Viewpoints — Hotter for Longer Could Equal Higher for Longer – But a Soft Landing Still Not Certain

Heading into last Wednesday’s Fed meeting, hotter than expected economic data and higher yields have been the story. As of late, the macro data seems to imply an economy that appears to be on strong footing with a 3.8% unemployment rate, a rebound in manufacturing surveys such as the ISM Manufacturing Index, initial jobless claims still subdued and August retail sales coming in hotter than expected. These developments have not helped the Fed in their fight to tackle inflation. Breaking news like a United Auto Workers strike with the potential to involve up to a hundred thousand employees and oil breaking above $92 bucks a barrel will not help either. Eventually, all these factors will likely be priced into markets.

Yields moved higher most of the month heading into the Fed meeting…and went even higher after it. Prior to the meeting a repricing of growth and inflation expectations were necessary based off recent economic data. It comes as no surprise that interest rate policy decisions and rhetoric from Fed Chair Powell came off hawkish and pushed the entire yield curve higher toward the end of the week. The 2yr, 10yr and 30yr yields all hit new highs for the cycle with some areas of the yield curve touching levels not seen since 2006. As of Thursday, the 2yr was as high as 5.19% and the 10yr as high as 4.48% which is above what many market participants saw as a key resistance level at 4.34%. Compared to the June meeting, there were many meaningful changes to the Fed’s Summary of Economic Projections that can be viewed as hawkish:

• 12 of 19 officials favored another hike this year.
• 2024 median Fed Funds rate forecast moved half a point higher to 5.1% (less easing).
• 2025 median Fed Funds rate forecast moved half a point higher to 3.9% (less easing).
  
  

Source: Summary of Economic Projections, FOMC – September 20, 2023

 Part of the hawkish tilt is likely due to increased growth expectations for the economy. The Federal Reserve’s forecasts for GDP have moved significantly higher since the June meeting, with the Fed now projecting 2.1% real GDP for 2023 up big from 1%. 2024 GDP projections were also increased to 1.5%, up from June’s projection of 1.1%. In addition, the unemployment rate was lowered to 3.8% from 4.1% reflecting what remains a very strong labor market. This was evident last week with Initial Jobless Claims coming in at 201k, 24k below expectations and the lowest level since January. Next year’s unemployment rate is now projected to hold steady at 4.1%, lower than previous estimates of 4.5%.

Source: Summary of Economic Projections, FOMC – September 20, 2023

It’s clear that the hotter-than-expected economy is leading to a higher-than-expected Fed Funds rate policy. But does this increase or decrease the probability of a soft landing? For those thinking we are looking at one, we would advise to not declare victory just yet. Investors should be weary with how the Fed can get down to a 2% inflation target WITHOUT slowing growth and doing damage to the economy. A “soft landing,” the Fed’s ultimate goal, may not be as likely a scenario as some investors would like to believe and a near term recession is still possible, perhaps likely. Many believe recent trends have only increased our chances of a “hard landing.” In a recent tweet, Wall Street Journal’s Nick Timiraos “The Fed Whisperer” mentions:

Nick Timiraos @NickTimiraos

Almost every hard landing looks at first like a soft landing

What's standing in the way of a soft landing now:

-The Fed staying too high for too long

-A too-hot economy

-A rise in oil prices

-A financial market rupture

…

7:55 AM - Sept 18, 2023

It’s probably fair to say there are plenty of tailwinds with the economy, but headwinds continue to mount. A hawkish Fed and elevated interest rates not seen in 15 years come to mind, but there are also “The Three S’s”: Shutdown, Student Loans & Strikes. None of them help the situation and when it comes to strikes, there are potentially more on the horizon such as the potential Keiser Permanente Health Care strike involving over 60,000 employees. Volatility is likely to continue in the months ahead given recent headlines and let’s not forget when it comes to recessions, it’s not a matter of if, but when. Regardless of the current backdrop we find ourselves in, future economic contractions cannot be avoided forever. One cannot simply change mother nature’s natural flow to avoid the dreaded winter cold and apologies for sounding like Thanos, but economic slowdowns are…inevitable. It would seem Timiraos is also trying to prepare readers for a reality check:

Nick Timiraos @NickTimiraos

…

 Planes land. Economies don't.

…

7:55 AM - Sept 18, 2023

Fortunately for long term investors, when volatility is around the corner, buying opportunities are usually not that far off.

CRN: 2023-0901-11087 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.