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We Are Still Watching the Fed

By ITR Economics on January 24, 2023

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ITR Economics

ITR Economics is the oldest, privately-held, continuously operating, economic research and consulting firm in the US.

You are likely aware that a US macroeconomic recession we had originally forecasted for mid-decade will now come earlier and characterize late-2023 and 2024, resulting from the dampening effect of the Federal Reserve’s frequent and unusually weighty interest rate hikes over the past year. The upside of the recession’s earlier arrival is the longer period on the other side of it – 2025 and the ensuing years – to fortify and prepare your business before the Great Depression of the 2030s arrives.

However, the forecasted length and severity of the 2024 recession is subject to certain variables tied to US monetary policy. These include:

1. An end to the current spate of rate hikes by the Federal Reserve

Today, growth is slowing for US Industrial Production, but growth is, for now, still occurring. We expect the deceleration will transition to actual decline in the annual trend (the 12-month moving average) as we enter the fourth quarter of this year. To mitigate the risk of that decline pushing beyond 2024 or coming in more severe than the relatively mild trend we are forecasting, the Federal Reserve will need to relax its aggressive monetary policy before we move past mid-2023 – i.e., before the industrial decline actually commences.

We are expecting a peak in the federal funds rate in the second quarter of this year, with confirmation of that peak in the form of toned-down Fed rhetoric – i.e., no more hawkish calls for increases – in the third quarter.

2. The “un-inversion” of the 10-year to 3-month Treasury yield curve

This factor is connected with the above and with interest rates coming down. The Fed’s pursuit of steep interest rate rise over the course of 2022 elicited a strong reaction from the bond market, with three-month Treasury yields rising above 10-year Treasury yields. This is clear evidence of a disturbance in the economic order; under normal conditions, an investor would receive a greater return – not a lesser one – for the lengthier investment. Once the Fed eases up on its aggressive monetary policy, the stage will be set for the 10-year Treasury to again exceed the three-month Treasury, by virtue of some combination of long-term yields rising and/or short-term yields declining. We are expecting this signal of relative economic normality to reemerge by the end of 2023, based on precedent regarding the duration of yield curve inversions.

Forecast Accuracy Stands Despite Risks and Complications

Transparency is one of our Core Values at ITR Economics, and disclosing risks and potential complications that could impact our forecasts is one way we enact that Core Value.

Another way we do so is by disclosing our forecast accuracy. Our preliminary forecast accuracy rating for US Industrial Production for 2022 came in at 98.9% at six quarters out. In other words, the outlook for 2022 that we published in mid-2021, without hard data past June 2021, was within 1.1% of what occurred 18 months later, and that was despite “the noise, uncertainties, political discussions, inflation, rising interest rates, war in Ukraine, concerns over food and oil, and significant COVID-related uncertainty in China,” as ITR Economics President Alan Beaulieu wrote in his blog last week.

You can trust our forecasts, and you can trust us to keep you apprised of a developing situation, even when that requires a change in a forecast.

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