The economy remains hot, likely too hot for the Fed

Current Trends

Consumers bucked the recent downward trend in spending as retail sales climbed sharply to kick off 2023, bolstered by resurgent job gains and still-tightening labor conditions. Factoring in higher-than-expected inflation readings for January, the economy remains too hot for the Fed, and the possibility of even more rate tightening this year is climbing. Businesses remain on edge as rising labor costs squeeze profit margins while key leading indicators — including the full inversion of the yield curve — suggest a likely recession in the year ahead.

Future Outlook

The conditions for a moderate recession over 2023-24 continue to build despite an acceleration in economic data to start the year. Job gains and consumer activity jumped in January, and inflation remained far above target; these lofty readings provide more reason for the Fed to tighten monetary policy to a sufficiently restrictive level. We expect that the Fed will lift rates further at upcoming FOMC meetings and keep policy restrictive for an extended period. Due to the continued strength of the labor market, a recession is unlikely to begin until at least mid-year, but signs of weaker activity are spreading across key sectors of the economy.