Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The US equity market, represented by the S&P 500 index, slipped 2% for the week ending December 16.
  • Some economists and market watchers are taking a soft landing (dissipating inflation, strong employment) for the economy off the table in 2023. While the Fed is sticking to its inflation-fighting script, a hard landing (rising unemployment, recession) is not inevitable next year.

At the start of 2022, the Federal Reserve embarked on one of its fastest interest rate hiking cycles in history to slow spending in the economy (“demand”) to quell inflation.

As Fed Chairman Jerome Powell said in a press conference earlier this year, when inflation is running hot, nuance goes out the window. The Fed has a job to do, regardless of whether higher gas prices or some snarled supply chain issue in Asia is the culprit.

Recent market events may indicate a shift in investor concern about inflation. A monthly jobs report released two weeks ago showed continued strong wage growth. If the stock market was worried about inflation, the report would have fueled a sell-off, as wage growth is viewed by the Fed and many economists as the primary driver of inflation. Instead, the market shrugged that report off and ended up higher for the day.

Then, on Tuesday, headline CPI inflation printed below expectations for the second month in a row. Instead of cheering low inflation readings and sending stocks higher, the market similarly shrugged that report off, and ended the week in the red.

Those two events could be signs that the stock market has become less worried about the Fed’s response to inflation and more worried about growth.

The Fed is not yet moved by this market sentiment shift, nor by the softer inflation data. When Mr. Powell was asked in his press conference this week about the recent data showing slowing inflation, he replied that nothing the Fed has seen has altered its view and that it would need “substantial evidence” that inflation was abating. He cited the Fed’s focus upon core services inflation less shelter, an interesting way of isolating wage pressures but not entirely consistent with his “no time for nuance” declarations earlier this year.

Mr. Powell and his brethren are sticking to the tough-talk script because the Fed wants financial conditions to remain tight. In what the Fed must view as insolence, the bond market has not been playing along. Bonds have rallied. The 2-year Treasury note yield has slid 0.5% and the 10-year has fallen from 4.2% to 3.5%, reflective of the view that the Fed will need to pivot to rate cuts in the not-too-distant future.

The consensus view at the Fed is that inflation cannot moderate without pain in the labor market and that there can be no “soft-landing” for the economy. While that view has been proven wrong in the recent short-term, should the soft-landing scenario continue to play out – strong wage growth, slowing inflation – it will be hard to predict what the Fed will do. In his comments, Mr. Powell remains open to a soft-landing outcome, but there will be debate.

Mainly due to the Fed’s commitment to stamp out inflation, however it chooses to measure it, there is near unanimity amongst economists that the US economy will fall into a recession in 2023. It has become fashionable to say it will happen in the second half of next year, which must be when higher interest rates finally do the trick.

There are still reasons for optimism: household debt service remains low, mortgage rates are falling, inflation appears to be slowing, China’s economy may finally be set to reopen and rebound, the median gasoline price in the US just fell below $3, and employment has held up. A hard landing is not a fait accompli in 2023.

Editor’s note: We wish all our readers a wonderful and safe holiday season! Our updates will resume in 2023.

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