Little Consensus On Economy In Second Half Of 2023

As we turn the calendar to the second half of 2023, there remains little consensus on where the economy is headed and what the Fed will do regarding interest rate policy for the remainder of the year. The bond market is currently pricing for rate cuts late in the first quarter or early in the second quarter of next year — which is essentially a call on when the business cycle changes — but market pricing for Fed policy has been very volatile so far this year.

The U.S. consumer has remained resilient to this point despite high inflation and rising interest rates, befuddling many economists forecasting a recession to begin as early as last year. To be sure, a recession will almost certainly occur at some point in the future. Business cycles change, and the Fed is effectively trying to initiate such a change to bring inflation down closer to its target level.

The bigger questions are when and how severe. The Fed’s efforts during the past 15 months have included 500 basis points of rate hikes and balance sheet reduction, but the downstream impacts on the economy are not instantaneous. The length of this lag varies by cycle and is inherently difficult to predict, but the economic impact isn’t zero. Corporate profits and profit margins have come under pressure, and interest burdens continue to rise. Consumer savings have been a boon for consumption during the past few years, thanks in large part to a deluge of stimulus during the pandemic. However, those savings have eroded in the past year, albeit at a slower pace than many expected and from a historically high base level.

As we’ve discussed in previous commentaries, liquid assets exploded higher in 2020 and 2021 amid pandemic-related federal stimulus. This metric rose $4.7 trillion in those two years relative to average annual growth of approximately $400 billion in the decade prior to the pandemic. In other words, liquid assets grew approximately $4 trillion more during those two years relative to the historical average. Savings began to erode last year, falling by $115 billion in the first quarter of 2023 and down $519 billion since peaking in the first quarter of 2022. However, consumers still have excess savings, which helps explain spending and, ultimately, inflation continuing to surpass expectations during the past year.

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Jason Haley joined ALM First in 2008 and is the firm’s chief investment officer. He heads ALM First’s Investment Management Group (IMG), which is responsible for leading the investment process and investment theme development. Haley also oversees all capital markets activities, including portfolio management, trading, market research and commentary, and execution of hedging and funding strategies for the firm’s depository clients. He holds an MBA with a concentration in finance and a BBA with a concentration in marketing, both from The University of Mississippi.