According to Michael Yoshikami, founder and CEO of Destination Wealth Management, the possibility of a U.S. recession in the near future might actually prevent a significant market downturn in the second half of 2023. This insight offers a glimmer of hope amidst the concerns surrounding the economic landscape.
In April, the U.S. witnessed a decrease in consumer price inflation, with a year-on-year rate of 4.9%. This marks the lowest annual pace since April 2021. This data, released by the Labor Department, was interpreted by the markets as a positive sign that the Federal Reserve’s efforts to control inflation are starting to yield results.
While the headline consumer price index had soared to over 9% in June 2022, it has since cooled down considerably. However, it still remains above the Federal Reserve’s target of 2%. In April, the core CPI, which excludes volatile food and energy prices, saw an annual rise of 5.5%. This increase reflects the resilience of the economy and the persistent tightness of the labor market.
The Federal Reserve has consistently emphasized its commitment to combating inflation. However, the minutes from the latest Federal Open Market Committee meeting revealed a division among officials regarding interest rates. Ultimately, they decided to implement another 25 basis point increase, bringing the target fed funds rate to a range of 5% to 5.25%.
Looking ahead, Chairman Jerome Powell suggested that a pause in the hiking cycle is likely at the FOMC’s June meeting. Nevertheless, some committee members still advocate for further rate hikes, while others anticipate that a slowdown in growth will eliminate the need for additional tightening measures. It is worth noting that the central bank has already raised rates 10 times, totaling 5 percentage points, since March 2022.
Overall, these developments highlight the delicate balancing act undertaken by the Federal Reserve as they navigate the complex economic landscape. As the markets await the outcome of future policy decisions, the potential impact of a U.S. recession on the market downturn in the latter half of 2023 remains an important factor to monitor closely.
According to CME Group’s FedWatch tool, the market is currently pricing in the possibility of rate cuts by the end of the year, with a nearly 35% probability that the target rate will fall within the 4.75%-5% range.
Looking ahead to November 2024, the market is assigning a 24.5% probability, representing the peak of the bell curve distribution, that the target rate will be cut to the 2.75%-3% range.
In a recent interview with CNBC’s “Squawk Box Europe,” Michael Yoshikami expressed his belief that the only scenario in which such rate cuts would occur is in the event of a prolonged recession. However, he considers this outcome unlikely unless there is further policy tightening, as falling oil prices could stimulate economic activity.
Yoshikami acknowledged the counterintuitive nature of his perspective, explaining that if the United States avoids slower economic growth or a shallow recession, it might be considered a negative because interest rates could continue to rise or not be cut. This poses a risk for the market.
The strategist also anticipates that more companies will adopt a conservative approach when providing forward earnings guidance. They will likely factor in the expectation that borrowing costs will remain elevated for an extended period, thereby putting pressure on profit margins.
Ultimately, the state of the economy in relation to a potential recession will play a critical role in market outcomes. If a recession is averted and the economy continues on its current trajectory, Yoshikami foresees challenges for the market in the latter part of the year.
Recent statements from Federal Reserve officials, such as St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari, suggest that persistent core inflation could lead to an extended period of tighter monetary policy and potentially necessitate further rate hikes this year.
Yoshikami emphasized that actual rate cuts would be a drastic measure, despite current market expectations. He speculated that policymakers might try to shape market expectations through speeches and public declarations, rather than taking immediate definitive policy action.
Given the precarious path of monetary policy and the U.S. economy, the experienced strategist urged investors to approach certain segments of the market, particularly in technology and artificial intelligence, with skepticism regarding valuations. He advised investors to critically evaluate whether the current stock prices align with their expectations for earnings over the next five years, as unwarranted optimism could lead to potential losses.