This week, the Federal Reserve kept its key interest rate unchanged. It is still in the 5.25%-5.50% range.
This is a strong confirmation that the U.S. economy remains on the right path. The Fed is clearly comfortable with the economic data so far. (Otherwise, it would raise interest rates again.)
Its “soft landing” scenario is still the most probable. Consensus estimates tell us that the risk of a recession is low.
However, things can still get out of control. We could see an unexpected economic slowdown, growing unemployment, a possible stock market crash, and more.
The odds are low at this point, but it always makes sense to prepare yourself for a range of outcomes.
Right now, the labor force remains strong, with the unemployment rate of just 3.8%. It’s in the normal range with no concerns about the current conditions.
Inflation is also on the downturn after a massive spike last year. Even with the latest reading slightly up, it’s still in a downtrend.
Jerome Powell, the Fed’s Chair, noted that inflation has calmed down over the last three months. However, the U.S. central bank is waiting to see what happens over a longer period.
This is why the Fed keeps shrinking its inflated balance sheet. Since March, when the Federal Reserve stepped in to support the country’s banking system, it reduced the balance sheet at an average rate of $25 billion per week.
Shrinking the balance sheet takes extra liquidity off the market and reduces total spending. Which, in turn, will be helpful to tame inflation in the future.
In other words, the Fed isn’t sitting and watching for the economy to heal itself. It’s fully engaged in the process.
Risks to Be Aware Of
But some things can still change the situation for the worse. Investors should watch out for these:
- Resumption of student loan payments. Over 44 million students will resume their loan payments in October. After three and a half years of relief, this may be a challenge for many. It should slow down consumer spending, which would reduce inflation further. But it may severely affect some households that already struggle with a high cost of living.
- The United Auto Workers (UAW) strike is the first sign that a strong labor force could produce unintended consequences, such as inflation. If labor costs rise, they could lift prices more than expected, and high inflation will continue.
- The rise in energy prices is another threat to the economic recovery. Higher oil prices may get the Fed to question its inflationary and monetary outlooks. However, this surge is orchestrated by the Organization of the Petroleum Exporting Countries (OPEC) and Russia. It won’t likely last very long as more oil supply will come to the market to fill the gap eventually, in our opinion.
These are the main things leading economists are watching. The Fed will also assess its economic stance before the upcoming meetings. It still expects another hike this year before pivoting to an easier monetary policy.
FedWatch, a tool that forecasts interest rate decision probabilities for the upcoming Fed meetings, assigns a 73.8% chance that the Fed will keep interest rates steady in November. Analysts don’t expect material changes to the central bank’s policy.
This is supportive of the economic recovery scenario, which we expect to become more apparent as soon as the Fed begins cutting interest rates.
In other words, be aware of the risks, but the economy and the stock market look like there’s no imminent danger ahead.
Thank you for your loyal readership,
The Financial Star team