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Economic strength and consumer resilience.

The latest economic data is continuing to underscore the strength of the U.S. economy, which may come as a surprise to many naysayers. Plenty of folks in the media have been talking about why it is too good to last, with the next economic doom fast approaching. Commentators and prognosticators are stymied by the resilient consumer, enduring labor market and continued positive economic numbers.

The data is counterintuitive to how the economy is supposed to react when the Federal Reserve raises interest rates as fast as they have over the past year. Much of this continued economic strength can be laid at the feet of U.S. consumer spending, which is being fueled by the strong labor market and wage gains.

While we would not count on all of the positive news continuing unabated, perhaps a tempering of the negative expectations of a full-on job losing, belt tightening recession is in order.

Inflation and interest rates.

It seems the Federal Reserve has done an admirable job of messaging and bringing inflation down to the 4% range. Now comes the task of bringing inflation down to the Fed’s 2% target. Progress on the inflation battle so far has been low hanging fruit, as we mentioned in our February 2023 note.

The next leg down toward the 2% range target is going to unfold over the coming two years. It will take longer and be more gradual than the initial decline, as the Fed aims for the soft landing: (1) slowing the economy to tamp down inflation; and (2) avoiding a recession. This was the reasoning behind the most recent interest rate pause. The Fed knows they have more rate hikes coming in 2023 and possibly early 2024.

The Fed is also waiting for the economy, and the markets, to digest the significant rate hikes they have already made. The impact of rate increases occurs with a significant lag, which means that future hikes will slow over time as we approach the appropriate level of inflation.