The Fed Reserve and inflation have been primary market talking points. Today we will take a look at recent trends in GDP and consumer demand. While the Fed is doing all it can - with its tools - to put the breaks on consumer demand and inflation, the data - across multiple key indicators - shows clear signs that the economy is starting to slow.

After two consecutive negative GDP growth quarters, The GDPNow forecast for the the third quarter of 2022 has been falling steadily since August when it was projected at 2.5% to sub 0.3% as of last week, Tuesday. We will have a better estimate of GDP for the third quarter by the end of October. The trend and forecast shows consecutive declining growth.

The trend in slowing growth is also reflected by declining activity in inbound containers at major US ports. This is considered a coincident demand indicator and reflective of immediate shifting trends in consumer demand. Global commodity and food prices are showing some signs of price easing but remain high year over year. Jonathan Golub, Credit Suisse;s chief U.S. equity strategist maintains that: "Futures indicate that Food and Energy prices should fall -5.7% and -11.8% by year end 2023, while Goods inflation has declined from 12.3% to 7.0% since February,” he wrote. “Over the past year, Services and Rents are up less than Headline CPI (5.5% and 5.8% vs. 8.5%).”

"Inflation" numbers predictably continue to shape the market narrative. As you may have read in our previous blog posts we continue to see this being the case until the economic data starts to show a consistent declining trend. While markets will look for early signs that the tide is turning, only consistent data will mark a tangible shift in the markets and a change in Fed sentiment.

Until that time, the Federal Reserve will continue to hike rates aggressively. They have made it abundantly clear that this is their number one priority and while they would like to avoid a recession that is not going to sway their intent to bring inflation into their acceptable orbit of less than 2% per year. Given the significant monetary forces that were put in motion since the inception of COVID it may take more time and hikes than anyone would like or anticipates.

A good analogy is being at the dentist for an unpleasant procedure that takes more time to resolve. We want it to end but it won't until the dentist is satisfied they have done the job. The Fed dentist wont be done until they meet their objective.

It appears that the Fed Doctors are leaning in the direction that more medicine is needed to keep the economy cool and inflation more tame.

We have maintained for many months now that this would be the Federal Reserve stance until the signs of inflation have shown a pattern of consistent decline. They failed miserably in quantifying the impact of their actions, inundating the economy in a sunami of close to zero interest funds and trillions of stimulus and now they cannot be seen to fail in bringing down "the inflation monster" they contributed in large part to create.

We expect the Federal Reserve to maintain a hawkish stance through this year and into the first half of the next year with the possibility of cutting the size of interest rate hikes as economic signs dictate. We then anticipate the Federal Reserve holding rates steady until a demonstrable period of time has passed indicating that inflation is more tame.

A recent research report released by Absolute Strategy Research revealed that 37% of money managers (who collectively oversee $5.2 trillion in assets) expect earnings to be higher a year from now. 63% expect earnings to be lower. That’s the lowest reading since late 2015.

The economic outlook is fraught with issues that we have discussed at length in prior articles.

a) Consumer sentiment has hit a 10 year low. This is correlated with more cautious consumer behaviour and a decline in spending which will impact earnings.

Inflation numbers continue to be the central issue shaping the market narrative. Last week’s market rally is based on the "not yet substantiated" narrative that inflation numbers will come down sooner and will necessitate less drastic action on the part of the Federal Reserve. In the short term, it's a speculative narrative.

The markets are forward looking so speculation is inevitably a component of how markets operate. However, the real determining factor will be the hard inflation numbers. Is inflation trending downwards? To answer this question will take several consecutive months of declining data to validate. Until such time, the Federal Reserve has no incentive - after miscalculating this issue through 2021 - to operate less hawkishly. Its credibility is on the line. As a result, they will look to declining inflation numbers over several consecutive months until they lighten their rhetoric and along with it, rate hikes. Until then, the Federal Reserve has no reason to veer off its already communicated path of more aggressive interest rate hikes.

The daily question and commentary that is in the news headlines - whether we will see a recession or not - is largely dependent on the still "unknown" question of "how long" it will take to bring inflation down and "how high do rates need to go for that to occurr"?