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Market Update

Rising rates and reluctance to cut the recession ribbon

Date:
August 1, 2022
  • Joe Rock headshot

    Authors

    Joseph Rock

    Associate
    Treasury Advisory

    Corporates | Denver, CO

Summary

For the second month in a row, the Fed increased interest rates by 75 basis points. The fourth rate hike this year has brought the target range to 2.25% - 2.5%. Second-quarter GDP figures showed a contraction of 0.9% annualized for the period. Now falling into two consecutive quarters of negative GDP, markets raise the question if the economy has truly met this common definition of a recession.

The Fed fires away

Continuing the path of aggressive tightening, the Federal Reserve increased the Fed funds rate by 75 basis points last week. The hike and magnitude, meeting predictions of experts, is expected to be one of several that will bring the Fed funds rate to a midpoint of 3.4% at year’s end according to the June FOMC member prediction. This current pace of rate hikes has not been as swift since the 1980s. In both instances, inflation was the catalyst. To supplement rising rates, the Fed also maintains it will continue to reduce its holdings of Treasury securities, agency debt, and agency mortgage-backed securities to fight inflation and achieve maximum employment. However, the labor market will take a back seat to combating inflation. The Fed indicated it would still raise rates despite any potential weakening in the labor market as long as inflation remains elevated. Achieving a soft landing will be difficult and Powell signaled awareness of the negative economic impacts from rising rates. Following the Fed meeting, market participants lowered their heightened rate predictions for year-end with few predicting declining rates by mid-2023 per CME Group. Equities appeared to respond positively, climbing higher by Friday morning towards the best month since November 2020. Treasuries stumbled, leading to further inversion of the 2-year and 10-year treasury yields. As this inversion is a strong recessionary indicator, many corporates brace for volatility ahead and assess paths to manage financial risk.

(Related insight: Read, “Corporate treasury leaders discuss hot topics at Chatham’s Financial Risk Management Summit”)

Realizing a recession

It’s unlikely there will be a ribbon-cutting ceremony for any recession. Few would like to attend such an event that would officially mark a significant decline in economic activity. Has the ribbon been cut already? Or will the occasion soon become inevitable? Many, like Chairman Powell, hope it won’t come at all. A small committee of eight prominent economists will decide when, and if, the ribbon is cut. This committee from the National Bureau of Economic Research (NBER), a century-old private nonprofit organization, will assess more economic factors than solely GDP figures — of which last week’s announcement of second-quarter GDP falling 0.9% contributed to the common definition of a technical recession. With first-quarter GDP measured at -1.6%, the back-to-back quarters of negative GDP raised the alarm for many. Like the NBER, experts and Fed officials have not pronounced a recession yet, mostly due to encouraging factors from the labor market, real personal income expenditures, and industrial production.

Nonfarm payrolls increased ahead of expectations to 372,000 jobs last month, the private sector has seen jobs exceed pre-pandemic levels, and the unemployment rate still sits at 3.6%. The Department of Commerce on Friday stated consumers raised their seasonally adjusted spending by 1.1% in June, up from a revised 0.3% increase in May. Encouraging durable goods figures were also released last week to a climb of 1.6% in June. This increase in demand was supported by a large increase in defense spending and motor vehicles. Still, with 40-year high inflation looming many economic figures are expected to cool over the course of the year with consumer sentiment at bleak levels. Powell stated, “I do not think the U.S. is currently in a recession and the reason is there are too many areas of the economy that are performing too well.” While it’s the Fed’s job to nail the soft landing, the reluctant task of cutting the recession ribbon will be of hot debate for the NBER committee.

(Related insight: Watch the webinar, "Semiannual Market Update for Corporations")

The week ahead

Job openings and quits, jobless claims, nonfarm payrolls, updated unemployment statistics, and more corporate earnings figures are expected to be released next week. Global markets will closely watch an expected 50- basis-point rate hike announcement out of the UK and the latest energy developments out of Europe.

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Disclaimers

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