Economic data showed some movements in the right directions, both up and down. The Federal Reserve responded by talking about letting the economy catch up to the rate increases already enacted. Does that mean that the path forward will be smoother and potentially skirt a recession?
The combination of even slightly declining inflation and unemployment releases over the course of October, and then a positive GDP reading for the third quarter, resulted in some much-needed optimism in the equity markets. The values of stocks have been benefiting from historically low interest rates.
Fed Chairman Powell’s relentless campaign of increasing interest rates to tamp down inflation has been having two impacts: the cost of capital for future growth is going up, and the fear that the Fed will overshoot and push the economy into recession compounds with every rate increase. The economic news provided some rationale to believe that the Fed would slow rate increases going forward.
After the FOMC meeting on November 2, The Fed indicated it is prepared to do exactly that. The statement on the rate increase included the key wording “the lags with which monetary policy affects economic activity and inflation.” This was taken to mean that the Fed could potentially decrease the size of rate increases.
The enthusiasm rally in the market was short-lived, as Powell elaborated in the press conference that the overall level of rate increases would likely be higher than previously communicated.
In practical terms, this means that uncertainty shifts from the amount of each monthly or semi-monthly increase in the Fed funds rate, to how many rate increases there will likely be in total. In other words – when will the Fed stop?
And more importantly, will it read the economic tea leaves correctly and stop short of recession?
Chart of the Month: Quarterly GDP
Quarterly GDP has rebounded to a more normal, positive level. Two consecutive quarters of negative GDP is one measure of recession, but the overall strength of the economy counterbalanced the dip in GDP in the first and second quarter.
Source: U.S. Bureau of Economic Analysis. Seasonally adjusted rates.
The Smart Investor
The Fed’s language on giving the economy time to adjust to rate increases has lowered expectations for the amount of upcoming interest rate moves. A 50-basis point move in December, and again in February now appear likely. Attention has shifted to how long the Fed will continue to increase rates.
Markets will likely remain driven by economic data releases, as we saw with the October payroll number out in early November. This means volatility will be elevated, as the fear of recession is still at the forefront.
As we enter the final months of the year, focusing on good housekeeping in your financial plan is important. High inflation has meant changes to social security benefits, tax brackets, and tax-efficient savings contribution limits.
Taking time to assess where you can take advantage to increase savings or lower your overall tax picture, not just this year, but every year, makes sense.
Good housekeeping chores include:
- Tax planning to take advantage of higher tax brackets
- Utilize increased contribution limits on 401ks and HSAs
- Revisit the amounts you are holding in cash in light of higher interest rates
- Be proactive with year-end portfolio rebalancing and tax-loss harvesting
Working with a financial advisor can help you bring all the pieces of your financial plan together.
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