It is not unusual for the Federal Reserve Board to tighten monetary policy when the economy is perceived to be over-heated, but such action rarely coincides with a period of back-to-back, negative Gross Domestic Policy (GDP) reports. However, in the first half of 2022, the Fed did just that with a string of rate hikes while the U.S. experienced -1.6% GDP decline in Q1, followed by -0.6% in Q2. Although the negative GDP reports might have been an anomaly given statistical quirks, the Fed’s rate hikes during this weaker growth period underscored their commitment to fight inflation. The Fed has not been alone as several other central banks have also raised interest rates. Nobody wants to be blamed for triggering a recession, so what is the Fed up to? As job layoff headlines emerge, the natural inclination is to assume “here we go again.” However, with a strong job market, supportive consumer balance sheets and high levels of fiscal spending, perhaps the Fed feels they have the flexibility to drive a “Great Reset” that cools inflation without causing a deep rut in the economy.
Unfortunately, rather than apply restrictive monetary policy as inflation emerged, the Fed was late to remove the proverbial punch bowl. The aggressive nature of recent interest rate hikes is due to the need to “catch up” for lost time. It’s not news to the Fed that monetary policy works with a lag. Many studies indicate it takes from six months to two years for an economy to adjust to each interest rate hike and the first increase in this cycle was only eight months ago. Although that timeline spells the potential for weaker economic growth into and through next year, we are in somewhat of a unique period given a set of supportive cross currents.
As economies continue the transition to pre-Covid conditions, supply chains are slowly reopening, and unfilled jobs should see increased absorption all while there is an immense backlog of approved fiscal spending packages. Regarding fiscal spending, the $1.2 trillion infrastructure bill was signed into law in November of 2021 and the Inflation Reduction Act of 2022 just passed in August. These large and newly approved, long-duration spending programs in the U.S. are only just starting to kick in. Although these fiscal spending packages likely demand more material inputs, in our view, they could function as a shock absorber as they will also necessitate more labor which helps support employment levels.
So far, the job layoffs have been centered mostly in industries that were pandemic beneficiaries such as technology and mortgage-related companies. In many cases, companies over-hired to support growth which has now begun to normalize. However, the vast majority of workers in the U.S. are employed by small businesses in the service economy. It is our belief that most employers will be reluctant to cut too deep given the scarcity of skilled workers (look what happened to the airlines). Particular to this cycle, there are over 10 million unfilled job openings as of August 2022 to work through before broad layoff considerations unfold. Lastly, consumer balance sheets are very healthy, evidenced by the current average FICO credit score in the U.S. of 716, matching an all-time high going back to 2005 when FICO started tracking the scores.
Bottom line, although an economic reset is uncomfortable, perhaps the Fed recognizes that the economy has some supportive tailwinds which will ease the economic shift caused by their blunt tools. Positive aspects to the aggressive pace of rate hikes are that savers are now earning a return on their cash, and should the Fed go too far, they now have room to cut rates if needed to reinvigorate the economy.
Sources:
https://money.com/average-credit-score-record-high
https://www.fico.com/en/newsroom/average-u-s-fico-score-remains-steady-716
https://www.cnbc.com/2022/08/30/credit-scores-are-at-an-all-time-high-despite-rising-consumer-debt.html
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