ECONOMIC NEWS BRIEF – May 27, 2022
- Economic uncertainty is likely to remain elevated until additional evidence of easing inflation pressures can be ascertained.
- We believe a recession could be avoided, but if one comes, we believe it would be relatively short and shallow.
- Investors should avoid material portfolio re-allocations at this time as we believe financial markets could be close to bottoming.
As of May 26th, the S&P 500 is down 12.2% year-to-date (on a total return basis) as investors anticipate an economic slowdown that has yet to materialize. For the last few months markets have been reacting to the idea that today’s high inflation environment may require aggressive Federal Reserve interest rate hikes, hikes that could lead to an economic slowdown or even recession.
Higher interest rates should be expected to slow the pace of economic activity. In some areas of the economy, such as manufacturing and housing, we’re seeing the early signs of such. Just how far the Federal Reserve will have to go in raising interest rates will depend on the path of inflation over the next few quarters. However, complicating this outlook is that much of today’s inflation stems from supply constraints rather than excessive demand – which is what higher interest rates are meant to contain.
Some price pressures have started to ease. Yet a few key costs, such as energy and housing, are at risk of seeing added upside in the months ahead, in our view. This makes these components particularly key to the interest rate outlook while offering potential downside to the pace of economic activity.
We believe the most likely path forward is one in which the U.S. economy avoids a recession. Regardless, financial markets already appear to be pricing one in. Financial markets have been responding not just to actual inflation and likely interest rate adjustments, but also to the uncertainty of how high rates could go. Even if the news is bad, financial markets prefer certainty over uncertainty.
An economic slowdown would also be expected to negatively affect corporate earnings.
Yet, as of this writing, forward earnings per share (EPS) estimates for the S&P 500 have seen little movement. In this brief report, we’d like to address two important questions:
- What might it take for the economic outlook, and thus financial markets, to stabilize?
- What factors are we looking at that lead us to believe that inflation might slow in the second half of the year as we currently predict?
Read the full report.