Rapid inflation threatens to derail expansion as Fed hikes sharply again, and promises more

Current Situation

Labor market conditions remain positive with further strong job gains for May and fast wage growth driving up incomes. But inflation accelerated again as the lagged impacts of excess money growth along with supply shocks for commodities and goods continue to drive up costs for businesses and consumers. Retail spending slowed for May while record-low consumer sentiment could translate into more downside ahead. Moreover, higher interest rates (with the Fed announcing a sharp 75 basis point rate hike at the June FOMC meeting) have weakened housing demand while reducing liquidity for financial markets.

Future Outlook

We are projecting a rare soft landing with Fed tightening and improvements on the supply side bringing inflation down while slowing – but not stopping – the economy. Despite a negative first quarter, real GDP growth for 2022 should remain a bit above trend. But further slowing should occur in 2023 as still rapid (if slowing) inflation and higher interest rates cut into consumer and business activity. The odds of a downturn in late-2023 or 2024 have risen as the Fed tightens further this year and next. A successful soft landing will require lower energy prices and significant supply chain healing, allowing the Fed to stop raising rates before the yield curve inverts.