What You Need to Know About the Looming Recession

The recession may be deepening. Inflation has been and continues to be underreported, due to the underestimation of the Owners’ Equivalent Rent (OER) component of CPI. OER, which is 24% of CPI, has been increasing lately. Combined with wage pressures and other economic challenges, this makes it difficult for the Fed to control inflation.

Despite this, stocks have been rallying in recent weeks. People are trusting that the Fed will engineer a soft landing that will bring inflation under control and ensure that interest rates will come down by year-end. While there are risks involved, there is a reasonable basis for this hope. Consumers have over $2 trillion in savings, the stock and real estate markets are sitting on a cushion of unrealized gains, most corporate balance sheets are healthy, and the CPI could indeed have seen its apex in June. The excesses that were present during the dot-com and real estate bubbles of 2000 and 2008 have been largely banished, with leveraged positions and bank solvency protected by sizable levels of liquidity and capital. The U.S. remains the center of global wealth, growth, consumption, manufacturing, and industry. Finally, the Biden Administration has taken a step to address energy inflation (in addition to the recently-enacted Inflation Reduction Act) via a little-noticed policy change that will allow the government to replenish the Strategic Petroleum Reserve using forward pricing for future delivery – a much-needed step that should help to stabilize current prices and encourage domestic exploration and development.

While the Fed may be able to fine-tune America’s economy, investment professionals are urging a defensive investment approach in the current risk-filled environment. There are too many adverse unknowns and unknown unknowns that could derail even the most well-thought-out investment strategy. Unless the Fed already has largely tamed the Inflationary Dragon (as markets presently believe), it will continue raising interest rates … until labor markets, businesses, and the stock market force it to stop. Even if it does pause its QT campaign prior to November elections, it is unlikely to do so for political reasons given inflation’s current trajectory. Even ending its current rate-raising campaign will not itself prevent stock, bond, and real estate markets from weakening. With all this in mind, it is important to remember Sgt. Esterhaus’s warning to Hill Street Blues: “Let’s be careful out there.”

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