One of the most fun icebreaker questions to ask other professionals is “What would you do if you weren’t in your current career?” For me, that question was always easy to answer. I would happily become a pilot. Airplanes and flights have always fascinated me, much to my mother’s fear. She’s not necessarily afraid of flying, but things can happen in flight, and she would rather me not be a pilot because pilots and planes are not without fault. If mistakes or unforeseen events occur in flight, they can sometimes end in catastrophe. Two of the most dangerous parts of flight are the takeoff and initial climb period as well as the approach and landing portion. In these periods of flight there are a variety of risks such as engine failures, bird strikes, weather related issues, and much more. Similarly, the economy is often most vulnerable to issues coming out of a recession and when it’s trying to avoid it.
Since the beginning of 2022, the Federal Reserve has been battling inflation. Inflation roared to a high in the Summer of 2022 with a reading over 9% on CPI. Currently, the CPI has trended lower to 3.7%. It actually was up mildly in August due to increased oil prices (which are highly volatile), but core inflation continued to trend lower with a report of 4.35% down from a peak of 6.6% in 2022. This lowering trend in inflation is important as it shows the Federal Reserve is having success in its efforts to curb inflation and slow down the economy. The main tool the Fed must lower inflation is through interest rates. They raised interest rates in the hopes of slowing demand, thereby reducing the rate of inflation. So far, the Fed has been able to lower the rate of inflation and keep unemployment below 4.0%, thereby making the “soft landing” scenario plausible.
Currently, the US economy is humming along at a 4.9% pace according to the Atlanta Fed’s GDPNow forecast. While we don’t expect the third quarter to end at such a high growth rate (we won’t have final numbers until the end of October), the economy seems to be expanding robustly. Additionally, this growth appears to be accelerating as 1Q23 GDP growth was 2.0% and 2Q23 growth was 2.1% according to the Bureau of Economic Analysis. Lower inflation, continued low unemployment, and robust economic growth support the idea of a “soft landing”. However, this does not mean that the skies are entirely clear and there is no danger as the Fed glides the economy towards a landing.
When examining the economy currently, a natural question to ask is “What could go wrong to mess this up?” Oftentimes in plane accidents the first thing to look at is pilot error. Similarly with the economy, the biggest concern right now is the Federal Reserve. The Federal Reserve releases a report four times a year called the Summary of Economic Projections. This report is kind of like a report card and guesstimate (highly technical term) on the future of the economy. During their September meeting, the Federal Reserve updated its summary report and a few notable things changed. The Fed increased their expectations for GDP in 2023 and 2024 to 2.1% and 1.5% respectively (from 1.0% and 1.1%), reduced the unemployment rate for 2023 and 2024 to 3.8% and 4.1% (from 4.1% and 4.5%), and increased their expectations for the federal funds rate in 2024 and 2025 by a 0.5% each year. On the surface, that should be welcome news. That means the economy is holding up well. Unfortunately, that means higher interest rates look like they will be here longer. More importantly, if interest rates stay higher longer and inflation continues to trend lower, that means that monetary policy gets tighter, or more restrictive, into 2024. Using our airplane example, the fear here is that the plane is approaching the runway quickly, so the pilots attempt to slow it down but end up reducing the speed too much so that the plane stalls and crashes. There is plenty of evidence to suggest the economy, and our plane, can handle this “braking” but an additional shock or shocks could prove problematic.
Outside of pilot error, or in addition to it, there are some other concerns as well. One such concern is the commercial real estate market. COVID brought a shift to the workplace and many companies don’t need the physical footprint of offices that they used to have. There is concern that as leases end and come up for renewal there could be an excess of properties for rent. This in turn leads to lower rental prices and reduced cash flow to the entities owning the properties. If the cash flow reduces too low, it could result in trouble for banks as entities could default or look to refinance their mortgages. Ultimately, this scenario could lead to financial losses for banks and a shock to the financial sector which hasn’t had a stellar 2023 already. Currently, the scenario isn’t playing out as negatively as it could. One such reason is that not all leases terminate at the same time. This gives owners an opportunity to rent their properties in a staggered fashion, so they don’t have a cash flow crunch. In addition, banks don’t want owners to default so they may be willing to work with them on better terms.
Another concern for the economy that will begin in the fourth quarter is the ending of two COVID era policies. Student Loan forbearance will end in September, as well as some extra aid to childcare. As consumers have to begin repaying student loans or paying more for childcare, consumption in other areas of the economy could taper off. This by itself may not be a huge concern, but in addition to other factors could present problems for the economy.
Finally, there are several other issues that could pose problems for the economy. Currently the union of autoworkers, the UAW, is on strike at several plants seeking a 40% pay raise. Automakers have offered 20% raises in negotiations. If workers continue to strike, a shortage of vehicles is likely to increase both new and used car prices, while agreeing to every demand of the UAW is likely to do the same. Vehicle prices feed into core inflation and could result in higher inflation. Additionally, economies around the world seem to be struggling with growth and inflation. Europe is having growth issues while China isn’t seeing the resurgence it thought it would. These issues by themselves are not enough to ground the economy, but together could pose a larger threat.
This is not a warning or a call for a recession, but a reminder that even though the economy is growing, there are issues to be concerned with. At some point another recession will come, that is a certainty, but it’s becoming less and less likely in 2023. The Federal Reserve seems to be confident in their actions and so far, the economic data on GDP, inflation, and unemployment supports them. For our clients, we do not see a reason to make large scale strategic changes to portfolios, but there are and will be opportunities to make some tactical changes. If you have questions or concerns, as always, feel confident contacting your advisor for a discussion.