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Category: Market Commentary Tags: , , ,

Are you worried about the economy? If you are, you’re not alone. Lately, there has been a lot of media noise surrounding the U.S. economy, driving panic among some viewers. If you have tuned into any major news outlet lately, the odds are you have seen some form of headline about the economy slowing down. Certainly, headlines like “Mortgage Applications at 22-Year Low”, “Inflation at 40-Year High”, and “Target Can’t Sell Their Merchandise” paint a picture of economic turmoil. But is it really as bad as it sounds?

Over the last three years, the United States has seen unusually strong economic growth. The expansion was briefly interrupted by the pandemic, but the Federal Reserve and federal government swooped in to provide swift fiscal and monetary support and stimulus, propelling the economy to a fast recovery. Stimulus provided directly to consumers, and a massive bond-buying program provided the economy with money to spend from top to bottom. A rapid ramp-up in demand faced off against supply chains snarled by shutdowns and other Covid-related measures. The imbalance resulted in inflation elevated to levels not seen since the 1980s. Beyond this inflation, though, the economy was humming. Unemployment was at a record low, consumer savings reached record highs, and real domestic GDP expanded at a year-over-year rate greater than 6% for three out of four quarters in 2021, its strongest run since 1984.

The Federal Reserve has a dual mandate; they strive to manage inflation and unemployment. The unusually strong economy allowed the Federal Reserve a prime opportunity to reverse policy to tame the high inflation without having to put too much effort into maintaining maximum employment. When inflation runs too high, the Federal Reserve has a few blunt tools to help slow it down by impacting demand. The first tool they took advantage of was raising the Fed Funds Rate, the rate at which financial institutions lend money to each other. When this rate rises, it trickles down to consumers, making it more expensive to borrow money and disincentivizes consumers from utilizing credit to buy things they could not otherwise afford. Dampening demand in this fashion helps normalize the supply/demand imbalance. So far this year, the Federal Reserve has hiked interest rates three times, with more rate hikes expected in the coming months.

As demand weakens, the economy slows. Typically, slowing economic growth is undesirable, but when inflation runs too high, the slowing demand can bring it down. With the economy being as strong as it is, the Federal Reserve has leeway to slow the economy without pushing it into a recession, but it may be difficult. The goal is to slow growth to more historically average levels, tamping down demand as supply chains untangle themselves, bringing down inflation as both sides of the supply/demand equation balance out. Another tool they utilize is forward guidance. By signaling future rate movements before taking action and describing what conditions would constitute what future action, interest rates tend to move ahead of the Federal Funds Rate, influencing consumer demand and preventing surprises in monetary policy from upending financial markets. There is evidence that the Federal Reserve’s efforts are working. Core CPI, which takes volatile food and energy prices out of the equation, has decelerated for two consecutive months, indicating that overall inflation may be beginning to roll over. Meanwhile, a variety of demand indicators have shown signs of slowing. New mortgage applications have fallen to a 22-year low, retail inventories have been rising, retail sales fell month over month in May for the first time in 2022, and the amount of consumer credit used in April slowed from its March increase. This slowing data would typically be bad news for the economy, but in a time where inflation needs to be tamed, they are signs that the Federal Reserve’s actions are working. For inflation to be brought back under control, the broader economy must slow down. It is possible for the Federal Reserve to slow the economy at just the right pace not to induce a recession while also slowing inflation, and early indications are that this is occurring. So, in a sense, the so-called “bad news” that has been coming out day after day about the economy slowing, when put into perspective, really isn’t bad news at all. Rather, it’s a sign that the steps being taken to rein in inflation are working, which most people can agree is some much-needed good news.


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