MacroResearchBoard

The Fed Is Hoping Against History – August 7, 2023

A just-published report updated our multi-asset recommendations and investment strategy. One of the critical differences that we have had with the consensus is that we do not envision the Fed et al will start cutting rates just beyond the near term. Monetary conditions are not restrictive, underscoring that global financial markets will be at significant risk when investors finally realize that policy rates will really have to rise higher and for longer than is currently discounted.

One of the oddities incorporated into the Fed’s forecast is that they do not envision a recession, yet foresee a 1% rise in the unemployment rate from current levels (thereby helping to bring down elevated and sticky service sector inflation). The historical record is not supportive of such forecast.

In the end, we expect U.S. economic growth to outpace the Fed’s (and the consensus) forecast, for the job market to remain tight and for core inflation to level off at a rate near 3% next year, with risks to the upside if growth firms, as we expect. If a significant loosening of the labor market in the form of a material rise in the unemployment rate is needed to bring core inflation down toward the 2% target, then the Fed will eventually have to engineer a recession via a more restrictive monetary policy than it is currently forecasting.