Stark disconnect between the Federal Reserve and Markets. After a year of the Fed’s drive to quell inflation, Wall Street investors still do not believe the Fed’s warnings. With December CPI numbers indicating a cooling of inflation from painful highs, investors are betting that the Fed will stop increasing interest rates soon and start cutting rates toward the end of the year to successfully navigate a soft landing. These optimistic views have propelled the Dow up approximately 2%, the Nasdaq up approximately 10%, and the broader S&P up approximately 6% year to date. However, if investors paid closer attention to members of the Fed, they would realize that they expect to raise their benchmark rate above 5%, implying more rate hikes of at least 50 to 75 basis points throughout the year.
The unemployment rate hasn’t been lower in half a century. Many Fed officials point to the robust job market as a factor likely to keep inflation high. The unemployment rate, 3.5%, is one of the lowest ever as businesses keep raising pay to keep and attract workers which fuels more consumer spending. The labor market is beginning to show signs of stress with highly publicized technology sector layoffs, and the rest of 2023 will bring slower hiring as the overall economy slows or tips into recession. The unemployment rate commonly masks other signs of weakness.
GDP data shows signs of stabilizing growth. US GDP rose at a higher-than-expected 2.9% annual rate in the fourth quarter of 2022. Much of the growth was driven by consumers who spent at a slower pace in the quarter, while business investment ticked upward at a weaker rate. Despite certain positive signs, economists are still concerned about the possibility of a U.S. recession. Surveys of U.S. purchasing managers found that higher rates weighed on demand in January along with a sharp fall in retail sales and existing home sales. On average, the probability of recession in the next 12 months is 63%, and many still believe the ‘soft landing’ will remain a mythical outcome which will never come to fruition.
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