It is a fitting quote from the Grateful Dead to apply to today’s United States economic environment. I realize applying a Grateful Dead quote to the state of a capitalistic economy seems to be a contradiction, but even basic economics have plenty of conflicts to sort through. And in this economy, there are plenty of conflicts.
After record stimulus, supply chain issues, and a resurgence of consumer spending post lockdowns, inflation raged higher and impacted our economy in ways not seen since the early 1980’s. Beginning in March 2022 with a nominal .25% increase in the Federal Funds Rate, the United States Federal Reserve raised interest rates 10 consecutive times since before pausing in the recent June 2023 meeting.1 The Federal Reserve raised interest rates to bring inflation under control. Unfortunately, it is hard to bring inflation under control without sacrificing something else, be it a slower economy or inflicting a recession. (In some cases, we have had high inflation and a slowing economy which is called stagflation. Stagflation plagued the United States during the 1970’s during the oil embargo and anemic economic growth.)
While only time will tell, the good news is that despite the aggressive stance on interest rates by the Federal Reserve, we have not witnessed a major slowdown in the economy. In essence, it “keeps truckin’ on”. There are several reasons as to why we have not seen a recession in 2023, and many economists are already taking it off the table for this year. The process of lowering inflation by slowing the economy has not yet played out as expected.
The first reason may be that housing seems to have adjusted to higher rates. The wonderful glory days of 30-year mortgages under 3% came to abrupt end but not before many Americans rushed to borrow or refinance at absurdly low rates. The once red-hot housing market began to cool as mortgage rates effectively doubled, leaving new borrowers with higher loan payments and a shift in affordability. But given the soft supply of new homes and higher than normal savings rates among consumers, housing is picking up again and weathering the storm. It is worth noting that housing is a major component of inflation.
Another reason for this goldilocks economic scenario is unemployment remains extremely low at 3.7%. Yes, this has increased from 3.4% in April, but these numbers remain historically low and have only marginally moved given the aggressive nature of the Federal Reserve.2 I suspect unemployment will continue to creep up, but we may be in a situation whereby it is manageable and remains within a reasonable level in an otherwise strong economy.
An economic piece that we may forget is that despite high inflation and the war in Ukraine, energy prices have dropped over the last year or so. As I am writing this, a barrel of West Texas Intermediate Crude stood at roughly $70.3 Over the last two decades, the United States has done two things remarkably well. The U.S. produces more oil than any other country in the world! 4 Yes, more than Saudi Arabia and Russia, two economic “gas-station” countries. And two, we continue to drive fuel efficiency across the country. Oil consumption peaked in 2005 for the United States and despite an increased population and continued economic growth, we remain below those 2005 levels ever since.5 It is also one of the reasons many states are looking to change how they tax gasoline sales at the pump.
For now, we are threading the needle of what many economists call a “soft landing”, whereby we can slow inflation but not stall the economy. For investors, a soft landing could offer reasonable returns and an environment that recognizes opportunities for those willing to remain committed to their financial and investment plan. Timing the stock market (or economics) is impossible. But adhering to the text-book principles of asset allocation, diversification, and long-term investing has a historical context that provides a basis for future reasonable results. Fragasso Financial Advisors guides our clients with those core investment tenets married to comprehensive financial planning.
While the economy can be puzzling, and the last few years have been a “long strange trip”, we should feel reassured that history has offered investors a roadmap that guides us through various economic and market cycles in progressing towards your financial goals.