SUMMARY
Consumer demand is at a critical juncture. We expect a downshift in consumer spending growth this year, but not a contraction. What's most relevant for forward-looking financial markets in 2022 is the pace of moderation. This will significantly determine the Fed's actions.
- A soft landing will require the Fed to raise rates and implement quantitative tightening in the right amounts and proportions to fight inflation without destroying consumer demand. Otherwise, a recession may ensue. It is this difficult task that causes us to weight our RESILIENT and RECESSION scenarios 45% and 35% at this time.
- Recessions begin when unemployment is at its lowest. US employment is now just 822,000 short of the pre-COVID record level. Labor force participation is also recovering at a solid rate even as the population grows. However, it is the rate of demand growth that determines the future need for labor, not the other way around. This means we are at a point of vulnerability – we are nearing full employment just as the Fed is implementing its substantial tightening policies.
- We believe consumer demand is slowing of its own accord, while the supply of consumer goods is now expanding. The impact of rate hikes and expected rate hikes will add further restraint ahead. The current trajectory of imports, production, and spending argues for a period of excess inventories to come and certain consumer goods prices to be marked down.
- With demand abating, inflation running hot (but cooling), and the Fed saying it will take the fight to inflation, we have an economy
at risk.
The risk is the Fed slamming the brakes too hard and fast for the economy to bear. - This is why we remain defensive in our investment strategy, waiting to shift tactically once we can see how hard and fast the Fed moves. While valuations are improving, for the time being, we would favor defensive staples rather than discretionary consumer goods producers within equity selection.
- With a sharp Fed tightening cycle priced into markets, we believe certain fixed income assets now offer compelling benefits to portfolios given their higher yields and diversification benefits.
