We endeavor to let people know what the upside and downside risks are in association with every forecast we publish. There are always risks that we must weigh when generating a forecast. In our written and spoken communications we highlight one or more upside risks to the forecast and the same for downside risks. What could happen that is likely to push results high? What event could make the trend weaker? We do this so that you may judge for yourself whether you agree with our risk position, and we do it to put you in position to monitor the data as it is released, so you can determine if any of the risk factors have been “tripped.”
Two known downside risks for our GDP and US Total Industrial Production outlooks through 2025 relate to monetary policy. “Known” risks is an important concept, because we all have learned that there are black swan events lurking out “there.”
Our forecast assumes that the Federal Reserve will cease its seemingly relentless push toward higher interest rates after the second quarter of 2023. We make this assumption based on examining prior inverse yield curves and measuring the duration of all prior inversions and taking the most probable timing based on the magnitude and speed of the increase in the federal funds rate. For most Federal Reserve Boards (specifically the Federal Open Market Committee, which is an interesting name given their function is to “influence” interest rates up and down), there is only so long they will stay out-of-synch with the bond market, as measured using the US Government 10-year Bond Yield.
Should the Federal Reserve push rates higher than 50–100 basis points in the first half of 2023, and should they push rates beyond that threshold beyond mid-2023, we run the risk of seeing the magnitude of the recession deteriorating into something more serious than the mild decline we are projecting.
ITR Economics is projecting that the recession will end in December 2024, as measured using the 12MMA of US Total Industrial Production. The GDP (adjusted for inflation) 3MMA is forecasted to establish a low in 3Q23. Prior instances shows us that there is a normal lag time between when an inverse yield curve rights itself into a normal yield curve and when the recession will likely conclude. Being economics, the timing is not like a metronome. We determine what is normal and what the median lead time is.
Based on prior inverse yield curves and our forecast for inflation, we think the Fed will/should be lowering interest rates by the end of 2023 (if it was our call, the rising trend in the fed funds rate would already be over). A combination of the short-term rate coming down and the long-term rate going up will get the marketplace back into a normal yield curve. We are assuming that this will occur by late 2023 or in early 2024.
Please keep in mind that there are many variables at play and this blog has highlighted two keys. Something else could crop up regardless of whether or not monetary policy stays on track with our projections. 2025 is a long way away.
- We will keep an eye on the disinflation trend and update accordingly.
- We will monitor the Fed’s actions in terms of the fed funds rising trend and also share the intel regarding what it all means.
- We will keep vigil regarding how long the inverse yield curve persists and what changes, if any, need to be made to our macroeconomic outlook.