So here we are: when investors don’t worry about inflation, they worry about recession. Tech companies are announcing increasing numbers of hiring freezes and layoffs. Homebuilders are beginning to report a slowdown in demand and the supply of existing homes is increasing. Walmart reported this week that it had excess inventory.
Isn’t that exactly what we wanted?
Except for some geopolitical shocks – the impact of the war in Ukraine on food and energy, and another round of COVID-19 lockdowns in China – the rebalancing we’ve seen in the US economy recent months reflects trends that were expected and desired when forecasters were thinking about 2022 late last year. The shifts in the economy that people are so worried about are largely what economists were hoping to see six months ago.
Let’s start with the housing market. It was overheating as recently as March, with stagflationary conditions. Inventories were at record highs and house prices soared even as mortgage rates rose from less than 3% to more than 4%.
At one point, affordability was going to be an issue, but it was unclear what level of house prices or mortgage rates it would take to calm things down. Two months later, we know – current asking prices and mortgage rates of around 5.5% have finally led to a rebalancing of the market. It’s too early to tell if this is a temporary pause or something worse, but the unhealthy pandemic boom in the housing market appears to be over for now.
Another trend economists were looking for was a shift from spending on goods to spending on services, as consumers took fewer pandemic-related precautions and returned to more normal behaviors. We are now seeing this happening. Amazon said in its quarterly earnings report that it found itself overstaffed in March and that Walmart was trimming excess inventory. Meanwhile, airlines and hotels are reporting strong demand and pricing power. Still, investors have become more anxious about signs of a slowdown in consumption of goods than they have been encouraged by the leisure boom.
For years, market watchers have worried about signs of scum in Silicon Valley and the cryptocurrency ecosystem. Countless companies with questionable business models have gone public over the past couple of years through the Special Purpose Acquisition Company or the traditional IPO process.
Now, in 2022, we see all of this falling back to Earth. Stock prices and the value of cryptocurrencies have been hammered. Money-burning companies like Peloton Interactive Inc. and Carvana Co. have announced layoffs. Venture capitalists are telling anyone who will listen to prepare for a more sober environment for the foreseeable future. The heady days for tech companies and crypto seem to be over for now.
All of these changes are necessary because inflation was too high and the Federal Reserve had to do something to contain it. At the start of the year, the market had pegged the Federal Reserve’s target rate at 1% in March 2023. Based on booming signals across the economy, that doesn’t appear to be enough to contain inflation. Today, expectations for the Fed Funds rate in March 2023 are more in the order of 3%. We do not yet know if this will be enough to bring inflation back to where the Fed wants it. But based on the slowing housing market, the containment of tech and crypto excesses and tighter conditions in the stock market, and additional capacity from Amazon.com Inc. and Walmart Inc., it’s now at least a possibility somehow it wasn’t in early 2022.
The question investors wrestle with is whether the Fed can manage this process and contain inflation without the economy tipping into recession. The irony is that if you asked forecasters in December what a healthy rebalancing of the economy and monetary policy would look like in the first half of 2022, they would probably say something exactly like what we are seeing now.
Conor Sen is a Bloomberg Opinion columnist. He is the founder of Peachtree Creek Investments and may have an interest in the areas he writes about.