FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
June 21, 2022

IN THIS ISSUE:

1. Fed Hikes Interest Rate By 75 BPS, Warns More Hikes To Come

2. Can The Fed Tame Inflation Without A Recession? We’ll See

3. Stocks Down Over 20%, Bear Market… What To Do Now?

4. 2Q GDP Will Tell The Real The Story On The Economy In July

Fed Hikes Interest Rate By 75 BPS, Warns More Hikes To Come

The Federal Reserve’s Open Market Committee (FOMC) voted last Wednesday to hike its Fed Funds Rate by 0.75% in an effort to head-off inflation which is running at a 40+ year high. The 75-basis point hike, the largest one-month increase since 1994, indicates how seriously Fed officials are taking the inflation threat after a string of worrisome economic reports. 

The latest move puts the key benchmark Federal Funds Rate at a target range of 1.50%-1.75%, up from 0.75%-1.00% previously, the highest level since the pandemic began two years ago. The Fed Funds Rate is the interest rate commercial banks charge each other to borrow or lend excess reserves they have or need overnight.

Fed officials also laid out an aggressive path of additional rate increases for the remainder of the year. New economic projections released after the latest two-day meeting showed policymakers expect the Fed Funds Rate to hit 3.4% by the end of 2022, which would be the highest level since 2008, and up significantly from the 2.5% peak it forecast in March.

Since its last policy meeting in early May, Fed Chairman Jerome Powell and other FOMC members had been saying there would be a 50-basis point hike at the June meeting and likely beyond, but the latest higher than expected Consumer Price Index report convinced all but one of the 12 FOMC members that the key interest rate should be increased by 75-basis points.

The Fed telegraphed its intention to raise the rate by 75-bps earlier in the week, so the larger increase was widely expected, and stocks actually moved higher after the move was officially announced last Wednesday afternoon.

In his post-meeting press conference, Chairman Powell also indicated there could be another 75-basis point increase at the next FOMC meeting on July 26-27 and perhaps even beyond. It appears clear now the Committee realizes the Fed is behind the curve in fighting inflation and as a result, it is likely we’ll see rate hikes at each of the four remaining policy meetings this year.

The Consumer Price Index hit its highest level in more than four decades in May as surging energy and food costs pushed prices higher, rising at an 8.6% annual rate last month. Chairman Powell indicated in his press conference that rising inflation is now clearly the Fed’s number one concern.

The Committee also voted to continue to shrink the Fed’s balance sheet by allowing its securities holdings to mature and not replace them. Doing so shrinks the Fed’s holdings by an estimated $47 billion per month or so, a process referred to as “quantitative tightening” or QT. The Fed’s balance sheet is now estimated to be just under $9 trillion. 

Can Fed Tame Inflation Without A Recession? We’ll See

It is clear now the Fed intends to raise short-term interest rates by whatever it takes to slow down inflation. While not saying so directly, this means a rate hike at each of the four remaining policy meetings this year, and Mr. Powell suggested there will likely be more rate hikes in 2023. So, the Fed Funds rate could approach 4% next year, the highest level since 2007 just before the financial crisis.

The question, of course, is whether raising short-term rates to that level will cause the economy to dip into a recession later this year or next year. Hiking the Fed Funds rate tends to create higher interest rates on consumer and business loans, which slows the economy by forcing employers to cut back on spending.

Chairman Powell acknowledged the rate hikes will have some negative effect on the economy, but he believes the Fed can pull off this rate hiking cycle without causing a recession. And he reminded reporters that the Fed will be monitoring the economy closely, as always, and will make corrections in its plans if necessary.

The Fed also released fresh economic and interest rate projections last Wednesday along with its official policy statement. The Fed now expects the economy to grow by 1.7% this year, down from its 2.8% projection back in March. It also expects GDP to grow by 1.7% in 2023 and 1.9% in 2024. Again, the Fed does not see a recession coming as a result of its interest rate hikes.

The Fed’s latest projections show the US unemployment rate, currently at 3.6%, to climb to 3.7% by the end of this year, 3.9% in 2023 and 4.1% in 2024. So, by that measure, the Fed is acknowledging its rate-hiking cycle will slow the economy but not to the point of a recession.

As to what the Fed expects inflation to do, the Fed’s latest economic projections include its forecasts for the Personal Consumption Expenditures Index (PCE), its favorite gauge of inflation. The Fed expects the PCE which was running at a 6.3% annual rate at the end of April (latest data available) to fall to 5.7% by the end of this year and 2.6% in 2023. It hopes to get inflation nearer to its target of 2% in 2024. That’s a tall order in my opinion.

Stocks Down Over 20%, Bear Market… What To Do Now?

The S&P 500 Index is down more than 20% from its record high reached in January of this year, so we are now officially in a bear market. Normally, a drop of 20% or more signals to investors that even lower prices lie ahead. As a result, many investors see this as a reason to move some or all of their equity allocation to cash or other asset classes.

If you believe stock prices are headed lower, the question is, where do you move your money in the current low interest rate environment? Bonds are not attractive now and cash is yielding next to nothing. So, what do you do? Answer: Look at some of the alternative investment strategies we offer at Halbert Wealth Management.

Meanwhile, Gross Domestic Product fell at an annual rate of 1.5% in the 1Q, following an increase of 6.9% in the 4Q of last year. Most forecasters predict an upswing in GDP in the 2Q, but should we see another decline, this will mean we are officially in a recession – which is defined as two or more consecutive quarterly declines in GDP.

The financial media is firmly convinced the Fed will not be able to pull off its rate hiking cycle without causing a recession later this year. I don’t remember the financial media being this negative on the economy since 2008 in the depths of the financial crisis. Naturally, all this bearish talk on the economy is driving stock prices lower.

2Q GDP Will Tell The Real Story On The Economy In July

Everyone in the forecasting world agrees that 2Q GDP will tell the story on whether we’re in a recession or not. If the number is negative again, then we’re in a recession; if it’s positive, then we’re not. The problem is, the Commerce Department doesn’t release its first estimate of 2Q GDP until the end of July.

That’s a long time for all of us to wait to know if we’re really in a recession or not. A few years ago, the Federal Reserve Bank of Atlanta developed a set of formulas for gauging what the economy is doing on a more current and frequent basis than that provided by the Commerce Department. The Atlanta Fed calls it “GDPNow” and it is updated on a daily basis.

So, what’s the GDPNow’s latest reading on the economy in the 2Q? The current reading is 0.00% as you can see below. As recently as mid-May, the Atlanta Fed’s model had the economy growing above 2% in the 2Q. But as you can see, the model has deteriorated significantly since then and now stands at zero.

So, what does this tell us? Not much, really, because we still have 10 days to go in June and as you can see, this indicator swings around a lot. It may continue to fall over the next 10 days, or it may rebound. It’s impossible to know.

If it ends-up clearly in negative territory, it will signal we are in a recession – two consecutive quarters of negative GDP growth. If it ends in positive territory, we’re not in a recession – at least most forecasters will conclude this.

What will happen if it stays at zero until the end of the month (which I doubt). In that case, forecasters will draw their own conclusions as to whether we’re in a recession or not.

But just remember, we don’t get the Commerce Department’s first estimate of 2Q GDP until late July. Until then, I wouldn’t put too much stock in the GDPNow reading unless it falls definitively below zero.

Keep in mind, we do get the Commerce Department’s third and final estimate of 1Q GDP next week on June 29, and it will be important to see where that comes in.

As always, I’ll be watching these upcoming reports closely and will keep you posted accordingly.

All the best,

Gary D. Halbert

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