Overview
- Early expectations for a potential recession have been met with mixed economic indicators
- The impact of higher interest rates on the economy is not yet fully resolved
- Consumer spending is a large driver of economic activity, but excess consumer savings has been declining
Background
Investors have been looking for a recession amidst rising interest rates and expectations for slowing growth, but continued growth in much of the economy and resilient investment performance in 2023 has made for a very murky economic puzzle going forward. Exogenous factors such as geopolitical instability, deglobalization, and continuing risk of a US government shutdown add complicating risk factors to the economic outlook.
Higher Rates, Resilient Growth
The current trajectory of Fed rate hikes began in March 2022, and continued unabated until the pauses this year at the June and September meetings. The Fed’s own future projection for the Federal Funds Rate, commonly called the “dot plot,” suggests Fed members continue to expect another rate hike before the end of this year. Market pricing suggests this view is not widely shared by all investors though. Persistently optimistic expectations around potential rate cuts have not panned out this year. Futures markets are presently pricing in greater than 50% probabilities that the Federal Funds Rate remains at its current level well into 2024, at which point rate cut expectations start to enter into the picture to balance out the expectations for further hikes. While inflation has slowed in recent months, US GDP continues to demonstrate positive growth, and the Fed recently upgraded its expectations for GDP growth in 2023 and 2024. The Fed may yet engineer the soft landing that market participants would like to see, but history suggests this has often been an elusive goal.
One gauge of recession likelihood is the Conference Board Leading Economic Index (LEI) for the US. This index currently suggests the US economy could be at risk for a recession despite positive GDP growth. The LEI has been in decline since mid-2022.
Consumer Impact
Consumer behavior is a strong driver of US economic activity, and incoming data suggests there are seeds for a consumer slowdown. Recent reports have indicated default rates on consumer debt are rising. The resumption of student loan payments will reduce some consumers’ ability to service their debt and may put negative pressure on overall consumer spending. Consumer savings increased during the Covid pandemic, but as time goes on, excess savings are declining, which could lead to a depletion of the spending capacity that has helped maintain economic activity since the onset of Covid.
Factors We Can’t Measure
Omnipresent geopolitical tension always presents the possibility of unexpected exogenous shocks to the economy. Current events may fuel reduced economic cooperation between some nations, reorganization of strategic relationships, and continued efforts toward deglobalization and onshoring of vital production capacity. A potential US government shutdown in November could also impact the domestic US economy. Investors may have expected to see one of these factors already further impact markets or the economy, but risks remain in this category.
Hiding Out in Money Markets
The inverted yield curve has incented investors to migrate into money market funds and other short-duration investments. With yields in excess of 5% and limited risk, not to mention the banking concerns following the collapse of SVB, investors saw an opportunity to allocate to an asset that might insulate against the other risks present in the market. Data from the US Treasury Office of Financial Research shows that assets in money market funds increased by 17% year-to-date through the end of August 2023. There is risk to over-allocating though to an asset with limited upside potential. An inverted yield curve is not “normal,” since investors should be compensated for the risk of longer-term investments with term premium, making this an arguably temporary circumstance. Predicting short-term interest rate movements is challenging at best, so investors need to have a plan for how they will move back into risk assets.
Our Position
Data and history suggest we might face economic headwinds, but every moment is unique and history and data do not predict the future. Investors should remain focused on long-term goals while remaining cognizant of the potential for additional market volatility. As always, we aim to assist clients in building nimble portfolio allocations that will capitalize on market developments.
Disclosures
The views expressed herein are those of Asset Consulting Group (ACG). They are subject to change at any time. These views do not necessarily reflect the opinions of any other firm.
This report was prepared by ACG for you at your request. Although the information presented herein has been obtained from and is based upon sources ACG believes to be reliable, no representation or warranty, express or implied, is made as to the accuracy or completeness of that information. Accordingly, ACG does not itself endorse or guarantee, and does not itself assume liability whatsoever for, the accuracy or reliability of any third party data or the financial information contained herein.
Certain information herein constitutes forward-looking statements, which can be identified by the use of terms such as “may”, “will”, “expect”, “anticipate”, “project”, “estimate”, or any variations thereof. As a result of various uncertainties and actual events, including those discussed herein, actual results or performance of a particular investment strategy may differ materially from those reflected or contemplated in such forward-looking statements. As a result, you should not rely on such forward-looking statements in making investment decisions. ACG has no duty to update or amend such forward-looking statements.
The information presented herein is for informational purposes only and is not intended as an offer to sell or the solicitation of an offer to purchase a security. Please be aware that there are inherent limitations to all financial models, including Monte Carlo Simulations. Monte Carlo Simulations are a tool used to analyze a range of possible outcomes and assist in making educated asset allocation decisions. Monte Carlo Simulations cannot predict the future or eliminate investment risk. The output of the Monte Carlo Simulation is based on ACG’s capital market assumptions that are derived from proprietary models based upon well-recognized financial principles and reasonable estimates about relevant future market conditions. Capital market assumptions based on other models or different estimates may yield different results. ACG expressly disclaims any responsibility for (i) the accuracy of the simulated probability distributions or the assumptions used in deriving the probability distributions, (ii) any errors or omissions in computing or disseminating the probability distributions and (iii) and any reliance on or uses to which the probability distributions are put.
The projections or other information generated by ACG regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. Judgments and approximations are a necessary and integral part of constructing projected returns. Any estimate of what could have been an investment strategy’s performance is likely to differ from what the strategy would actually have yielded had it been in existence during the relevant period. The source and use of data and the arithmetic operations used for calculating projected returns may be incorrect, inappropriate, flawed or otherwise deficient.
Past performance is not indicative of future results. Given the inherent volatility of the securities markets, you should not assume that your investments will experience returns comparable to those shown in the analysis contained in this report. For example, market and economic conditions may change in the future producing materially different results than those shown included in the analysis contained in this report. Any comparison to an index is for comparative purposes only. An investment cannot be made directly into an index. Indices are unmanaged and do not reflect the deduction of advisory fees.
This report is distributed with the understanding that it is not rendering accounting, legal or tax advice. Please consult your legal or tax advisor concerning such matters. No assurance can be given that the investment objectives described herein will be achieved and investment results may vary substantially on a quarterly, annual or other periodic basis. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information.
Gryphon Financial Partners shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This was created for informational purposes only. Gryphon Financial Partners, LLC is an Investment Adviser.