A look ahead: Third quarter 2023 outlook
Interest rates and inflation outlook
A strong labor market, fueling solid consumer spending, has helped both economic growth and market optimism but in our view a slowdown and possible recession has most likely not been averted, just delayed.
Certainly, the combined rate hikes from central banks across the world are likely to be draining financial liquidity. And while the economic impact of this lags, we think it is a question of when, not if, the economy feels its full impact.
Ironically, a strong economy now increases the odds of recession down the road if it keeps inflation elevated due to several factors. Under that scenario, the Fed would raise rates higher, tightening financial conditions further, which in turn would raise the odds of a policy mistake and a recession.
Currently, the bond market is expecting rates will rise an additional 0.5%, and we agree. While we do think more rate hikes are risky insofar as they increase the chances of a policy mistake (which could lead to a recession and a quick policy reversal to begin cutting rates), we expect the Fed to deliver the hikes, nevertheless.
We expect the Fed will raise rates 0.25% in July, then another 0.25% in the fall.