Views On The Economy Have Shifted Dramatically Over The Past Year

Stocks rallied last week, with the S&P 500 rising 2.5% to close at 4,719.19. The index is now up 22.9% year to date, up 31.9% from its October 12, 2022 closing low of 3,577.03, and down 1.6% from its January 3, 2022 record closing high of 4,796.56.

Inflation continues to dominate conversations about the markets and the economy.

But the nature of those conversations have shifted significantly over the past year. This evolution can be seen in how the Federal Reserve’s language has changed from meeting to meeting.

At the Fed’s December 2022 policy meeting, Chair Jerome Powell warned: “Inflation remains well above our longer-run goal of 2%. … It will take substantially more evidence to give confidence that inflation is on a sustained downward path.”

The core PCE price index — the Fed’s preferred measure of inflation — turned lower in mid-2022. FRED

At the time, inflation rates had begun to come down from their mid-2022 highs — but confidence wasn’t particularly high that they would come down to comfortable levels in the near term. Everyone agreed interest rates would be hiked further in 2023. And many economists were convinced that the cost of defeating inflation was a recession.

Fast forward to present day after four more interest rate hikes. At their December 2023 meeting this past week, Powell acknowledged, “We're seeing inflation making real progress.”

Indeed, inflation rates have come down significantly. The core PCE price index — the Fed’s preferred measure of inflation — has cooled to 2.4% on an annualized rolling three-month basis. TKer would go as far as to argue inflation is no longer a crisis.

The Fed has been hiking interest rates aggressively since March 2022. FRED

Impressively, the economy absorbed higher interest rates and realized lower inflation without having to go into recession. To get a sense of how surprising this was, check out: TKer's 2023 chart of the year 📊

Today, we are no longer talking about more rate hikes. Rather, we are now talking about expectations for rate cuts in 2024.

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Normalization Has Come With Fading Tailwinds

Disruptions caused by the COVID-19 pandemic led to bottlenecks across the global supply chain. With supply lagging demand, inflation picked up in 2021 and into 2022.

As more and more people were able to go back to work, supply chains eased and supply gradually caught up with demand. This helped ease inflation, even as economic growth persisted — suggesting the goldilocks soft landing scenario that TKer described in January.

More recently, the massive tailwinds that have defined excess demand have faded significantly. Specifically, excess savings are nearing depletion, job openings are coming into balance with unemployment, and business investment orders have leveled off.

The ratio of job openings relative to the number of unemployed people is near prepandemic levels. (Source: FRED via TKer)

And while economic normalization has been good news for inflation, it also means demand is not as hot as it used to be.

Normalization also means debt delinquencies are coming up from unusually low levels and could eventually mean metrics like the unemployment rate and layoff rate also come off from unusually low levels.

Zooming Out

The pandemic era economy has been an unusual one. The initial disruptions were unprecedented. With the unusually strong positive developments over time came unusually problematic challenges like inflation rates surging to levels the world hasn’t seen in 40 years.

And the pace and nature of the economic recovery has been almost unimaginable. 

“I have always felt,” Fed Chair Jerome Powell said on December 13, “since the beginning, that there was a possibility, because of the unusual situation, that the economy could cool off in a way that enabled inflation to come down without the kind of large job losses that have often been associated with high inflation and tightening cycles. So far, that's what we're seeing.”

As things normalize, we can expect areas of strength to fade, which could present new challenges. But we should also expect new positives to emerge as unusual headwinds like high inflation dissipate.

A version of this post was originally published on Tker.co and appears here with permission.