Since the Federal Reserve began raising interest rates aggressively in 2022, economists and investors agreed that a recession loomed in the near future. The only question seemed to be how dramatic the downturn might be.
But a funny thing happened on the way to the inevitable recession: The U.S. economy just kept growing. Second-quarter gross domestic product (GDP) came in above expectations. Meanwhile, the national unemployment rate in June was just 3.6%.
The outperformance comes in spite of central bank policy that has been designed to slam the brakes on economic growth. The Fed raised interest rates at 10 consecutive meetings in 2022 and 2023, took a break in June, then enacted another quarter-point hike in July.
At his July 26 news conference, Federal Reserve Chairman Jerome Powell said the Fed’s own analysts have stopped calling for negative economic growth. “The staff now has a noticeable slowdown in growth starting later this year in the forecast, but given the resilience of the economy recently, they are no longer forecasting a recession,” he told reporters.
Others are reaching a similar conclusion. “At the start of 2023, a soft landing seemed like a pipe dream, but it’s more and more on the table as a possible outcome,” said Sean Snaith, director of the University of Central Florida’s Institute for Economic Forecasting. “We’re probably facing more of a ‘near recession’ now than an actual one.”
In a sign of how fluid the economic picture is, just last month in this space, we quoted a prominent economist who indicated that a U.S. recession was a foregone conclusion. Now, though, the conventional wisdom around that topic has changed.
The ever-shifting outlook illustrates a reality of investing at the moment. Investors faced a period of intense uncertainty early in the pandemic, followed by a couple years of outsized returns. The return to reality, and to economic uncertainty, underscores the wisdom of our focus on high yield investment opportunities with best-in-class operators across a variety of asset classes.
The inflation picture comes into focus
When the pandemic spurred the highest rise in consumer prices since the early 1980s, the Fed was caught flat-footed. Powell infamously characterized rising prices as “transitory.” But by June 2022, the U.S. inflation rate topped 9%.
After Powell initially downplayed the threat of inflation, the central bank has been in full inflation-fighting mode. From early 2022 through July 2023, the Fed pushed rates from zero to 5.25%.
“We’ve raised the federal-funds rate now by 525 basis points since March 2022,” said in his late July news conference. “Monetary policy, we believe, is restrictive and is putting downward pressure on economic activity and inflation.”
Fed policy seems to be achieving its goal of reining in prices. As of June 2023, the U.S. inflation rate had cooled to 3%, according to the Bureau of Labor Statistics. Still, Powell says the consumer price index (CPI) is still well above the Fed’s target rate.
“The June CPI report, of course, was welcome, but it’s only one report, one month’s data,” Powell said. “We hope that inflation will follow a lower path as was — that it would be consistent with the CPI reading, but we don’t know that, and we’re just going to need to see more data.”
He pointed to a separate inflation measure, the Personal Consumption Expenditures (PCE) index, which was up 3.8% as of late July.
The relationship between inflation and asset values is complex. Inflation creates tailwinds for real estate valuations and can spur higher rents. On the downside, inflation leads to higher interest rates, which means the cost of borrowing to buy property goes up, and higher wages.
Despite continued predictions of a recession just around the corner, the labor market keeps humming along. In June, the U.S. economy created 209,000 jobs, and the unemployment rate fell to 3.6% from 3.7% the previous month. Average hourly wages increased 4.4% year over year, to $33.58 an hour.
The unexpected strength of the economy probably isn’t what Powell expected, but he acknowledged the new reality in his recent remarks.
“The overall resilience of the economy, the fact that we’ve been able to achieve disinflation so far without any meaningful negative impact on the labor market, the strength of the economy, overall that’s a good thing,” Powell said. “It’s good to see that, of course … you see consumer confidence coming up and things like that. That will support activity going forward.”
