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  • John M West III, MBA, CFP®

Is this time different?


The U.S. economy continues to roll along despite labor strikes throughout the country, budget wrangling in D.C., unthinkable wars in Ukraine and now Israel, and weakness in China. Historically, the fight to lower inflation has been a trade-off between stable prices and a weakening labor market. However, the economic data remains robust as the employment picture stays strong. During every other rate hiking cycle, the Federal Reserve has increased rates to a level where economic growth has slowed. Companies were forced to lay off workers, which reduced consumer spending and ultimately brought down prices, lowering inflation. This time has been different.


Since March 2022, the Fed has lifted interest rates nearly a dozen times to a range of 5.25% to 5.5% and is likely at or near the end of raising rates. Headline inflation has fallen from a peak of 9.1% to 3.7% on a year-over-year basis but is still above the target of 2%. Yet, the unemployment rate in the U.S. sits at 3.8%, which is only slightly above the 3.6% that prevailed when the Fed first started raising rates.


Understanding why the labor picture has remained so strong is important to inform us of where we go from here. It appears to be a combination of things, including generous fiscal COVID stimulus, strong labor-force participation, a boom in small-business creation, continued growth in the service sector, and a reluctance to lay off workers due to difficulty in hiring qualified labor after the pandemic.


The labor market’s persistent strength has surprised the Federal Reserve and almost everyone on Wall Street, who have adjusted their unemployment forecasts and postponed or withdrawn once-rampant recession predictions. The economic slowdown has not arrived. Overall, consumers (the biggest driver of the U.S. economy) appear healthy, and corporate balance sheets are in good shape, with little need for debt issuance to fund growth. Despite these positive signs, we still believe that an economic slowdown is coming.


It is important to remember that the Fed rate hikes move through the economy with “long and variable lags” that can be anywhere from 18 to 24 months (see Kyron’s commentary). The first rate hike occurred just over 18 months ago, so we are just now getting into the initial time period where these hikes will begin to affect the economy.


As the jobs market remains robust, consumers are starting to feel the squeeze of higher rates with credit card delinquency rates rising, tightening lending standards at banks with mortgage rates nearing 8%, and student loan payments beginning again for 40 million Americans. An economic slowdown still seems likely based on these headwinds, but not as prolonged or severe as the Global Financial Crisis (2007 – 2009). We are closely watching the third-quarter earnings season, which starts this week. Not only will we be scrutinizing the results but also the guidance going forward to see if consumer spending is truly impacted by higher rates. During the year, earnings have been more robust than expected and are expected to rise more than 10% over the next 12 months. Earnings and forward guidance both hold keys to where stocks go from here.

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