What picture is current economic data painting?
The traditional account of the business cycle is very familiar. An expanding economy eventually runs short of the resources needed to supply demand, prices rise, central banks hike rates to curtail inflation, and the economy slows. Then, inflationary pressures ease, central banks cut rates, demand grows, and the cycle starts afresh. To interpret the future of the economic expansion, let’s take a look at the current data picture.
Interpretation may vary...
Has the Fed already tightened too much?
Bond markets seem to be saying the Fed has raised short-term rates too much, although equity markets are buoyant. We think that the flat yield curve has more to do with a changing view of longer-term inflation than expectations of an economic slowdown, but we’ll look at the following indicators for confirmation of this view in the months ahead.
Financial conditions are now at their loosest since 1994, according to the Chicago Fed’s index. We will watch to see if future data echoes this message.
Or is the Fed making a mistake by pausing?
While we expect incoming data to confirm that the Fed has not gone too far in hiking rates, we also need to be cognizant that keeping rates on hold increases medium-term risks. We will be watching:
Base case and investment positioning
In our base case, we think inflation will rise at only a modest pace, allowing for a continuation of the steady-growth, low-rate backdrop we have experienced over the past few years. But with higher valuations curtailing future investment returns, and the possibility of volatility as the market frets about Fed policy errors, US–China trade, and other market risks, we keep a more balanced exposure to risky assets, and use hedges where appropriate. See Our preferences for our full list of tactical recommendations.