So far 2022 has been a year where just about everyone on Wall Street got it wrong. As did the Fed and all global central banks. Back in December, strategists at the world’s top investment firms like JPMorgan Chase & Co. predicted the S&P 500 would gain 5% in 2022. Economists saw the U.S. 10-year Treasury yield hitting 2% on average by the year’s end. And even Goldman Sachs Group Inc. lent credibility to the claims that Bitcoin was on track to hit $100,000.Yet six months later, an unprecedented confluence of shocks has ended one of the most powerful equity bull markets and sent safe-haven government bonds and other assets spiraling. The S&P 500 is down 23%, 10-year rates stand at 3.23% and Bitcoin has shed more than half its value.
Since the beginning of the year, everyone has been trying to guess if the Fed will manage to control inflation without causing a recession? Now everyone's trying to guess whether the next recession is going to be mild or severe on the economy and how long it can last?
Policymakers decided on a more aggressive rate increase after the May inflation report last week came in hotter than anticipated and some preliminary surveys suggested consumers’ inflation expectations could be rising.
Policymakers on Wednesday increased the federal funds rate by three-quarters of a percentage point, to a range of 1.5% to 1.75%, the largest hike since 1994. Chair Jerome Powell, who has vowed to raise rates until there’s clear and convincing evidence that inflation is abating, told reporters at a post-meeting press conference that another 75 basis-point hike, or a 50 basis-point move, was likely at the Fed’s next meeting in July. Officials forecast rates will rise to 3.4% by December and 3.8% by the end of 2023. Those would both be the highest levels since early 2008 when the US economy was on the cusp of the financial crisis. The forecast Gross Domestic Product (GDP) growth to slow to 1.7% this year compared with a 2.8% expansion projection in March. Unemployment could rise to 4.1% at the end of 2024 from 3.6%.
Powell acknowledged that the Fed was not seeing signs of moderating inflation that it had expected by this point and suggested he was essentially powerless against some of the key forces driving inflation expectations higher, namely energy and food. What he can do is use higher interest rates, he said, with the goal of “moderating demand” a central bank euphemism for hurting parts of the economy. Powell said he doesn’t want to cause a recession, but that’s sometimes unavoidable when central banks endeavor to rein in inflation. This particular situation is only becoming more perilous.
Federal Reserve Chair Jerome Powell is trapped in a dilemma that’s essentially guaranteed to keep the central bank at the mercy of inflationary forces, not in control of them. The Fed’s monetary policy tools are useless against surging global food and energy prices, but they’re starting to play an outsized role in rising inflation expectations — a situation that could embed rising prices in the national psyche. It’s clear the Fed is focused on crushing inflation at the expense of a soft landing.
An economic model maintained by Federal Reserve Bank of New York economists suggests the chance of achieving a “soft landing” for the US economy is just 10%. “According to the model, the probability of a soft landing defined as four-quarter GDP growth staying positive over the next ten quarters is only about 10%.” the economists wrote in a blog post published Friday on the bank’s website. “Conversely, the chances of a hard landing defined to include at least one quarter in the next ten in which four-quarter GDP growth dips below -1%, as occurred during the 1990 recession are about 80%.” Also, on Wednesday, the Federal Reserve Bank of Atlanta cut its estimate for second-quarter growth to 0%.
Consumer spending accounts for about two-thirds of US economic activity, and in the first quarter, it was the segment that performed relatively well even as government expenditure fell and corporate investment lagged. But there are signs that Americans are growing less willing to spend and are generally weaker. Inflation is taking a bigger bite out of incomes, forcing Americans to dedicate more of their spending to basics like food and gas and leaving less room for discretionary purchases. That is leading to higher inventories at Walmart Inc. and Target Corp. and also pushed the savings rate in April down to the lowest since 2008.
US retail sales fell in May for the first time in five months, restrained by a plunge in auto purchases and other big-ticket items, suggesting moderating demand for goods amid decades-high inflation. Spending in recent months has been supported by consumers dipping into savings and increasingly using credit cards. That dynamic could put overall retail sales growth at risk as Americans’ financial foundations weaken. Six of the 13 retail categories showed declines last month, according to the report, including electronics, furniture, and e-commerce. Several economists downgraded their forecasts for real spending and gross domestic product following the report.
The inventory to sales ratio for broad range of us retailers which include Walmart and target is now at highest level since the bursting of the dot com bubble. Major U.S. retailers like Walmart Inc. and Target Corp. are also sitting on inventories of $45 billion, up 26% from a year ago, which they bulked up during the pandemic to overcome shipping delays.
Consumer confidence has been sinking all year as households shoulder the burden of higher prices, and President Biden’s approval ratings have also suffered. Both Wall Street economists and small business owners increasingly worry that a recession is possible in the next year.
“The Federal Reserve is going to hike interest rates until policymakers break inflation, but the risk is that they also break the economy,” Ryan Sweet, Moody’s Analytics head of monetary policy research, said in a research note. “Growth is slowing and the effect of the tightening in financial market conditions and removal of monetary policy have yet to hit the economy.” And Guggenheim Chief Investment Officer Scott Minerd said the US may already be in a recession, given the slowdown in consumer spending.
S&P 500 index now is in a bear market means it has completed the requisite 20% plunge. In the last 95 years when S&P500 has been in a bear market, the American economy did not shrink within a year in only three of those episodes. Among 14 recessions over the span, only three weren’t accompanied by a bear market. How far can this selloff go? If history is any guide, more pain may lie ahead. Since 1927, the median bear market had tended to last 1.5 years, with the S&P 500 falling 34% over the span. Of all the previous 14 cycles, only three ended in less than four months.
The content published above has been prepared by CFI for informational purposes only and should not be considered as investment advice. Any view expressed does not constitute a personal recommendation or solicitation to buy or sell. The information provided does not have regard to the specific investment objectives, financial situation, and needs of any specific person who may receive it, and is not held out as independent investment research and may have been acted upon by persons connected with CFI. Market data is derived from independent sources believed to be reliable, however, CFI makes no guarantee of its accuracy or completeness, and accepts no responsibility for any consequence of its use by recipients.