Cooler trends, but only modestly so

Highlights from the Monthly Review for February 2023:

The U.S. economy is in the late cycle period with the Fed expected to tighten monetary policy further to slow still rapid inflation. Key leading indicators (including the yield curve) point to elevated recession risks over the next year, although the labor market has been resilient to rate increases to date.

Key Takeaways: 

Economic Review: Cooler trends, but only modestly so

Job growth in February was far lower than January’s stunning surge, while retail spending pulled back broadly. But services inflation was hot again as labor conditions remain too strong to meaningfully slow price increases for consumers — adding pressure on the Fed to continue rate tightening despite the disruptions across the banking industry. (pg. 2)

Financial Markets: Markets shaken by banking stress

Revelations of several bank failures unnerved investors, causing equities to surrender much of their early 2023 gains and adding to worries about flattening profit margins this year. Long treasuries topped four percent at the start of March as inflation proved more persistent. However, the yield rally ended as fixed income markets priced in an accelerated end to the Fed tightening cycle. (pg. 3)

The Outlook: Limited imbalances point to a milder downturn

While the economy continues to perform quite well on balance, there have been several signposts in recent months to suggest that the recession risks are still elevated. Federal Reserve tightening has inverted the yield curve, bank lending standards have turned more stringent, and consumer expectations have faltered. There remains some scope for a soft landing, but it is diminishing steadily as the lagged effects of higher interest rates and quantitative tightening continue to take hold. At the same time, there is little to point toward a deep downturn anytime soon, as the imbalances that often build over the course of long expansions are largely absent in this case. Household and corporate debt burdens are both relatively muted, for example, while leverage in the financial system has been reined in substantially since the Global Financial Crisis.

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