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Viewpoint
September 5-September 18, 2022Viewpoint VIEWS, PERSPECTIVES AND READERS’ LETTERS
What to expect when you’re expecting a recession
Where will the second half of 2022, and even 2023, take us? The Wells Fargo Investment Institute, believes the economic cycle will run faster, interest rates will rise further, and the economy and capital markets will remain fragile in the months ahead as we likely head toward a moderate recession.
Uncertain about how to respond or what actions to take next?
Let’s start by unpacking what this forecast means for both your investments and wallet. CRONK
Prepare, don’t panic
If you feel anxious just hearing the word “recession,” keep in mind that
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recessions are a natural part of every economic cycle. In our Wells Fargo Investment Institute Midyear Outlook, we discuss the hallmarks of a recession, how long and deep this moderate one may be, and what Federal Reserve actions may a ect the job market and interest rates. Make thoughtful decisions
When you hear about a recession, you might feel the need to take action in the moment, like ipping a light switch. Our recommendation is for a “dimmer switch” approach for equity portfolios and more, along with talking to a professional advisor to assess your needs vs. wants.
Take stock of priorities and options
Even if you don’t have a big investment portfolio, now is an opportunity to re ect on the quality of your investments and make sure you’re making the right decisions, nancially and psychologically. It’s time to review the Great Resignation, how much cash you should have on hand, and consider the risk of trying to time the markets.
Explore insights
For help determining what to do with your portfolio while facing the unknowns of the remainder of this year and beyond, visit the WFII site at https:// www.wellsfargo.com/investment-institute/. CRBJ
Darrell Cronk is the chief investment officer for Wells Fargo Wealth & Investment Management.
Money growth slowdown has some economists worried
We have argued for some time that the underlying cause of the current soaring inflation rate was the surge in money supply growth that began in March and April 2020. Money growth skyrocketed as the Fed expanded its balance sheet by $3.0 trillion in the spring of that year. The Fed continued to buy securities every month from then until the end of March 2022 and money growth remained rapid. It flooded the economy with trillions of dollars of excess liquidity. e M-2 measure of the money supply is the sum of a number of di erent assets that can be used to purchase goods and services. Speci cally, it consists largely of checking accounts, savings accounts, money market fund balance, and small CD’s that we could be used to purchase something today if we were so inclined. In short, it measures what’s in our wallet. If we have money in our pocket it tends to burn a hole, so rapid money growth can stimulate spending which, in turn, boosts in ation.
Typically the M-2 measure of the money supply grows by about 6.0% every year which is roughly in line with the growth rate of nominal GDP. At its peak year-over-year growth in M-2 peaked at 27% in February 2021. Its growth rate subsequently slowed but continued to expand at roughly a double-digit pace through the end of 2021.
But beginning in February of this year and continuing through June money growth has slowed dramatically. In the ve-month period between February and June M-2 was unchanged. at dramatic slowdown in money growth has gone largely unnoticed. Of the economists who have paid attention some now fret that 0% money growth is far too slow and the Fed is likely to push the economy into a deep recession if the lack of growth in the money supply continues.
We do not share their concern about non-existent money growth — at least for the foreseeable future. e reason is that when money growth soared in the spring of 2020 and for the next 18 months, the level of M-2 climbed farther and farther above its trend path. It currently stands $3.6 trillion above its desired path.
It will take years to eliminate that excess liquidity. If the Fed can cause M-2 to decline at a 4.0% pace every month going forward, the bulk of the excess liquidity will be eliminated by the end of next year. But the Fed is not going to allow money growth to decline at a 4.0% pace for an extended period of time which means surplus liquidity will be ample for several years.
As long as there is surplus liquidity in the economy it is unlikely the in ation rate will shrink to the Fed’s desired 2.0% pace.
We believe that the 9.1% year-overyear increase in the CPI for June was probably the peak in ation rate. It will slow, but to what? Will in ation approach the Fed’s desired 2.0% target in ation rate quickly? Or will it prove to be more stubborn and remain above 5.0% for the foreseeable future?
We expect the CPI to increase 8.1% this year and slow to 5.2% by the end of 2023. Excluding the volatile food and energy categories, we expect the so-called core CPI to rise 6.0% this year and 5.2% in 2023.
All of those numbers are more than double the Fed’s 2.0% target.
If that is the case, the pressure will remain on the Fed to keep raising interest rates. At its meeting in June the Fed suggested that a federal funds rate of 3.4% by the end of this year and 3.8% at the end of 2023 would be su cient to reduce in ation to 2.7% by the end of next year.
But, as we see it, the Fed is not going to slow growth if the funds rate remains below the in ation rate — i.e., the real funds rate remains negative. Even the Fed seems to believe this. In its longer run forecast, to produce 2.0% in ation the Fed needs a funds rate of 2.5% — a positive real rate of 0.5%..
How high rates will eventually need to
go depends greatly upon how quickly the in ation rate slows. If the Fed is right that in ation slows quickly to 2.7% by the end of next year, then a 3.8% funds rate should do the trick and allow the Fed to actually lower rates in 2024. But if we are right and by the end of 2023 the in ation rate remains elevated at 5.2%, the funds rate will need to be 5.0% or higher. At the end of 2023 we expect the funds rate to be 5.0% and the in ation rate to be SLIFER 5.2% — still slightly negative in real terms. e market currently believes that the Fed will be right, in ation will slow quickly, and the Fed may be in a position to reduce rates by the middle of 2023. If we are right, both the stock and bond markets are wildly optimistic and will eventually have to do a rethink. As always, we will see. CRBJ
Stephen Slifer, former chief U.S. economist for Lehman Brothers, can be reached at www.numbernomics.com
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