Despite some recent positive signs for the U.S. economy, Wall Street generally believes a recession is lurking. A strong labor market and services sector, combined with recovering housing data, appear to point to a solid, if not stellar, U.S. growth outlook. But with the Fed’s rate hikes underway and the question of how long consumers can bear the pressure mount, the economy is facing a number of dangers that could lead to at least a modest contraction. “Our most likely scenario is that by the end of the year the economy will be stuck in a A mild recession as surveys show consumers retrench and business hiring slows,” , in a note to clients. The pair even compared the current situation to the climate of 2007, when the financial crisis crippled the global economy, before recovering in early 2009. They see similarities in the Fed’s positioning, when officials mostly expected dark clouds in the housing market to pass, instead they feared inflation would hit around 5.5% by mid-2008. “It is difficult for policymakers to manage periods of economic regime change,” Roach and Gillum said. “The current environment is likely to be very similar to early 2007, when the Fed had a tightening bias on interest rates because they believed the housing market was stabilizing, the economy would continue to expand, and inflation risks remained.” Still, LPL doesn’t see “another 2008 2019,” although “investors should expect some volatility as the economic outlook remains cloudy.” From an investment perspective, LPL favors a “neutral” style allocation, favoring international stocks, large caps over small caps and Industrials as sector picks, and communications and technology from technical factors. Improved data points Current indicators offer conflicting signs about the likelihood of a recession. Consumer confidence actually rose in June to its highest level since February, according to a widely followed University of Michigan survey. There was also good news for real estate, with operating rates unexpectedly surging nearly 22% in May. Finally, the Atlanta Fed’s GDPNow incoming data tracker showed growth of 1.9% in the second quarter, following a 1.3% annualized rate in the first quarter. Despite the swift start to the year, others on Wall Street are cautious about stocks. For example, investment management giant BlackRock sees significant economic risks from Fed policy and is advising clients to be cautious. “As central banks try to bring inflation back down to policy targets, a recession is on the horizon. This is the opposite of past recessions: In our view, rate cuts will not help support risk assets,” said the firm, which manages $10 trillion in assets. asset clients, said in a report this week. BlackRock focused on upward revisions made by Fed officials to their economic outlook after last week’s policy meeting. “We think the Fed’s improved growth forecast ignores the stark trade-off it faces: curb growth or live with inflation,” the firm’s strategists wrote. Historically low unemployment has raised its growth forecast. In our view, the Fed may be relying on a broken employment-growth relationship.” hold. “The new playbook calls for a constant reassessment of the extent to which the economic damage done by central banks is priced in,” the strategists said. Barriers to a soft landing Likewise, DBRS Morningstar warned in its assessment of the U.S. and Canadian economies, especially after the Federal Reserve Sectors that get hit when rates are raised. “Overall, we expect both economies to slow to a near-stall pace in the second half of 2023, as the lagged effects of monetary tightening are fully passed through,” wrote Michael Heydt, senior vice president of global sovereign ratings at DBRS Morningstar. “That would imply cooling consumer spending, a deeper downturn in interest rate-sensitive sectors, or both. Given that outlook, a recession is likely.” Federal Reserve Chairman Jerome Powell dismissed Wednesday Responding to claims of economic weakness, he told lawmakers on the House Financial Services Committee that economic growth was “very strong” and “by far the strongest in many countries.” However, Wall Street remains concerned that the central bank will not be able to achieve the soft landing it had hoped for. “Consumer balance sheets are deteriorating, manufacturing is contracting, the labor market is cracking, commercial real estate is collapsing, and banking stress remains,” wrote Megan Hornman, chief investment officer at Verdence Capital Advisors. The hiking cycle usually doesn’t end without a recession. “With rising stocks and a strong labor market, optimism around a soft landing is building,” Horneman said. “We think a soft landing is unlikely.”
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