This week we got some good news on inflation. Markets rallied.
But does that mean the worst is behind us from an economic perspective? We learned last month that the broadest indicator of economic growth, GDP, declined for two straight quarters. By some definitions, that indicates the economy entered a recession in the first half of 2022.
If you are confused about the economy right now, you’re not alone. There has never been more of a mixed bag of indicators. While the economy shrunk during the first half of 2022, 3.3 million jobs were created, and the job market fully recovered from the pandemic. While we adjust into a more normal post-COVID world, so does the economic data. Not only do COVID and unprecedented monetary and fiscal policy continue to impact markets, but the impact is embedded in the data in ways that confuses even the smartest experts. The economy may be on more solid ground than some headlines would lead you to believe, but that doesn’t mean we are out of the woods.
Let’s look at where we stand on some key indicators, recent market trends and what it all could mean going forward.
Peak inflation in the rearview?
Inflation has been a huge overhang for the market, but recent information has investors cheering. Both CPI and PPI (producer price index) showed signs of cooling in July, giving investors renewed hope that inflation can finally begin a steady decline in growth from here. Sharply falling gasoline prices, commodity costs and an easing in the price of some goods all played a role in slowing inflation.
Consumer outlook for inflation is improving too. Measures of inflation expectations from the New York Fed Survey of Consumer Expectations released earlier this week, and recent trends in the University of Michigan consumer sentiment survey, show consumers think price increases will slow from here. This suggests inflation is unlikely to become an untamable, self-fulfilling prophecy, which is the Fed’s greatest fear. In Fed terms, inflation remains anchored.
That said, while the Fed may take some comfort in the outlook by consumers, it could take a while before inflation returns to a comfortable range. The central bank’s favorite gauge of inflation is the Personal Consumption Expenditure (PCE) which was at 4.79% on a core basis (excluding food and energy) in June and remains well above the Fed’s 2% target.
Weakness in other indicators
There’s some light at the end of the tunnel on the inflation front. And the job market remains hot. Other economic indicators point to sluggish business activity, fueling arguments that a recession is here despite a still strong job market. Unemployment claims have been on the rise since mid-March while the growth rate in real personal income is negative. As a result, Americans’ Personal Saving Rate is now at the lowest level since June 2009. Meanwhile, Leading Economic Indicators (LEI) appears to have peaked earlier this year.
A strong summer rally
Amid all these varied economic signals, financial markets have found their footing. The S&P 500 notched a low on June 16th at 3,667 while the all-important 10-Year Treasury rate is down big from its June 14th high of nearly 3.5%. Those are encouraging trends, but what’s worrisome is the Treasury yield curve – it is the most inverted since 2000, a telltale sign of a true recession. While there are still so many question marks, stabilization in the stock and bond markets signal that there is some confidence in the future of inflation and Federal Reserve interest rate policy.
Piecing together the puzzle
That’s a lot to digest, right? I come back to the fact that stocks and bonds appear to feel better now than they did two months ago. After all, trading markets are forward-looking while so many economic data are backward-looking. Much of the bad news might already be behind us. Investors now enter what is often a sketchy period. Historically, September and October are notoriously volatile, sometimes featuring big stock market drops. After a more than 10% rally since mid-June, a bearish seasonal trend is good reason to temper expectations. I expect this market to continue to be reactionary and driven by headlines until we have more clarity on where exactly inflation is headed as we approach 2023.
The bottom line
The economy is not falling off a cliff, but there are some troubling signs. Still, the bulls can point to a very strong job market and corporate earnings that did not suggest a slowdown was hurting company profits. Stocks big and small have recovered impressively in the last two months despite a very mixed bag of economic data. Staying diversified and not getting rattled by the occasional dire headline is more important than ever.
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Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.