The backdrop of the COVID crisis and its monetary policy and fiscal responses have created some wild macro cross-currents. We recently deep dove into those in a recent blog (the new interest rate environment). In this piece we will focus on the different trends currently at play and what might lie ahead for the economy in the second half of the year.
Employment Growth
A big driver of the economy is employment growth. More employed people means more income which translates into more spending and consumption (which is what the GDP measures)*. Currently the employment growth remains very healthy, well above its long term average. We have certainly seen some headlines around job cuts and hiring freezes in the tech industry, but broadly the employment rate remains strong (as seen by the July payroll data). The main implication from this is that the risks of a sharp recession are very low. As the chart below shows recessions tend to be associated with employment contraction which is very different from what we are experiencing currently.
Credit Growth
Credit growth is a big driver of economic growth. It is undeniable that the low interest rate environment has been very stimulative for the creation of credit, and the current credit growth should provide some tailwind to the economy (currently growing at 10% per year). There are signs that credit growth could slow down, as banks have started to tighten their lending standards but again those standards are far from recessionary levels.
Inflation
As we reviewed recently, we are of the view that current inflation was created by inadequate monetary and fiscal response given the combined demand and supply shortfall. This overstimulation first created inflation in goods which then spurred into services. On top of this, an energy crisis emerged with the war in Ukraine. At present, we are well past the goods inflation peak (as depicted by retailers slashing prices to decrease inventories). As the chart below shows oil has also stopped moving higher and generally commodities have also rolled over..
On top of this we are also seeing (chart below) some leading indicators related to price pressure in the manufacturing sectors abating. It is more likely than not that as the rate hikes start to take effect inflation will start coming down.
Overall
While the economic environment remains complex the strong employment picture coupled with the credit growth should provide some tailwinds for the economy while in the background we might expect inflation to start coming down. This should prevent the Fed from hiking rates well into the restrictive area (ie above 5%). This would ultimately imply the Fed rate peaking around 3%-4% and staying in the zone for a bit given the relatively strong economic backdrop.
Ben Verschuere - Chief Investment Officer
Treasure Investment Management, LLC
Disclaimer: The views and opinions in this piece are just the author’s own, offered to the public at large and not to any one particular investor.
(*) There is a mathematical relationship between employment and GDP as real GDP is the product of the total hours worked and the total factor productivity.
