Highlights from the Monthly Review for July 2023:
Recent readings suggest that the expansion will carry into the second half of 2023 despite sharply higher financing rates for businesses and consumers in response to the Fed’s rate tightening. But leading indicators for the economy still indicate that recession odds are high over the next year, which should result in an eventual, even if delayed, economic downturn.
Economic Review: Hiring activity slows, but labor market is still tight
June saw weaker job growth and a downward trend for labor demand in many industries. But wages rose further due to continued tight labor conditions, breathing more life into incomes and consumer spending. With core inflation only cooling very gradually, the question for the Fed in coming months appears to be: how many more rate hikes will it take to finally slow inflation? (pg. 2)
Financial Markets: Equities in rally mode
The S&P 500 added more than six percent in June, leaving the index only eight percent under its all-time high. Second quarter 2023 results, however, are providing a challenge to optimistic investors, currently forecasting a drop of more than six percent. Fixed income investors also face issues with a looming Fed hike casting a long shadow. (pg. 3)
The Outlook: Is Fed policy restrictive yet?
Despite the fastest Fed tightening cycle in the past half century, labor market and inflation trends have remained buoyant into mid-year. One reason could be that the level of the fund funds rate given the rate of inflation is still not yet restrictive enough. The real fed funds rate (fed funds target rate adjusted for core CPI inflation) was still near zero in June. Historically, the real fed funds rate has been positive by several percent ahead of prior recessions. Current readings suggest that the Fed may have to raise rates even higher to bring inflation to heel. That said, a continued easing in the pace of inflation will also lift the real fed funds rate even once the Fed stops raising rates.
While rhetoric from Fed officials will continue to be hawkish in response to lingering services and housing inflation, we expect only one additional rate hike at the upcoming July FOMC meeting. But the Fed will be prepared to make more tightening moves later this year if labor and inflation data remain too hot.