Inflation vs. The Economy: What's Changed?

By: Edward Jones
DEWITT, Mich. - June 21, 2022 - PRLog -- Our $23 trillion dollar economy doesn't turn on a dime, but underlying economic conditions have shifted in historically quick fashion of late, with the narrative taking on a new (less favorable) shape following the most recent inflation report.

We have held a view that the economy is enduring a midcycle slowdown. While threats like ongoing supply-chain disruptions and high oil prices are credible, our economic model, which evaluates forward-looking signals from fundamental trends across a series of factors, has also indicated encouraging support from key areas such as the labor market, credit conditions and corporate profits.

We're careful not to place too much weight on a single data point, but it's become apparent that the latest consumer price index (CPI) report (released June 10) marked a change in the market's tenor and highlighted a more challenging economic path, as persistent inflation requires an even more restrictive response from the Fed. This has, to some degree, dashed the prospects of the economy maintaining its momentum long enough for inflation pressures to subside without this more aggressive Fed action. Markets have responded in knee-jerk fashion, dipping to a 2022 low amid rising recession fears.  In our view, things are not as bad as the current market volatility may make them seem. And while there is no instant elixir for this bout of indigestion, we think patience and discipline will ultimately be rewarded.

Investment Synopsis:
  • Headline inflation has remained stubbornly high amid geopolitical shocks to oil and food prices along with lingering supply bottlenecks.
  • The Fed is being forced to further accelerate its rate-hiking campaign in an effort to quell inflation expectations, raising risks of a Fed-induced recession.
  • There are still bright spots for the economy, but headwinds have grown, as we appear to be in a phase where consumer anxiety over inflation may have a self-fulfilling effect on weaker personals spending, despite a favorable labor market.
  • Both stock and bond markets have moved toward "worst case" views. We don't think the reactions are irrational, but we do think they're pricing in a degree of pessimism that may be overshooting, creating a more compelling risk-reward outlook in which potential upside is increasingly attractive relative to the near-term challenges.

Our Economic Health Indicator Is Signaling Increasing Headwinds

Our cycle model has moved lower recently, and while it's not consistent with a more assured recession, several of the signals we monitor tell us we're enduring a late-cycle phase. It's worth emphasizing that conditions are still similar to 2011 and 2016, which proved to be midcycle slowdowns. And while it is still quite feasible that the economy can avoid an outright recession, the eye of the needle that the Fed is trying to thread has narrowed.

Edward Jones - Mae Luchetti
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