With investors embracing a soft landing (misguidedly, in our view), it could happen yet again. With the benefit of hindsight, this was the case coming into the year, as everyone expected the most anticipated recession ever, as it has been called. Sentiment measures typically work best as contra signals. Improving economic sentiment in recent weeks, just as the window for a recession may (finally) be opening, moderately reinforces our view that a recession is the likely outcome in the next year. Yet economists and market strategists may be premature in declaring “all clear,” as the lagged effects of monetary policy should begin to truly slow economic growth in the coming quarters. We concur, as investors and corporate decision-makers typically focus much more on what they think will happen in the future than what has happened in the past when making capital allocation decisions.įor example, consumers are much more likely to buy a house or car today if they think prices will be higher in a year, and they will focus less on what has recently transpired with prices. In calculating the real rate, Powell’s preference is to use a mainstream measure of near-term inflation expectations as opposed to actual inflation. Most investors focus simply on the level of interest rates, but most academic research – and the Fed’s models – focus on the level of interest rates relative to inflation.
This means monetary policy should be tight enough to curb inflation and slow economic growth. equity markets have checkered histories in correctly sniffing out recessions: in the six months before one began, stock markets delivered positive returns 42% of the time, and 25% of the time in the three months prior.ĭuring his July 26 Federal Open Market Committee press conference, Fed Chair Jay Powell specifically referenced that the real (inflation-adjusted) federal funds rate is now in meaningfully positive territory (higher than inflation). Investors should keep in mind that resilient U.S. economy often experiences sharp deteriorations in momentum as recessionary forces arrive. The key drivers supporting a soft-landing scenario are debatable, and the recent run of improving economic data is certainly positive, but history shows that the U.S.
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