What may we expect within the economy during the coming months?

“Improving economic conditions, which culminated with stronger than expected second quarter real gross domestic product readings in both Europe and the United States have downshifted investor concerns of a recession during 2023.

The question now is whether economic growth slows slightly or precipitously over the next few quarters resulting in no recession, a short shallow recession, or a deeper recession sometime next year. Market consensus has shifted from expecting a 2023 recession to questioning whether economic growth remains resilient, forcing monetary authorities to tighten policy further, resulting in a delayed but deeper recession. CPM does not foresee a soft landing, but a recession. CPM has projected a recession emerging around 2024 – 2025 for some time, and not in 2023. We are adhering to that projection even as the consensus shifts from one side of our expectations to the other.

There is a lot of uncertainty at this time regarding what comes next. Tightening monetary policy so far has helped slow inflation growth with only minor negative impact on economic growth appearing in the housing and auto markets. Honestly, other factors have exerted greater negative pressures on both housing and auto sales than higher interest rates. The better than expected economic performance overall can be explained in part due to reduced supply chain bottlenecks, which were an important contributor to inflation growth during 2021 and 2022.

Also, while U.S. interest rates now are at their highest levels since 2001 or so, they are lower than they were for most of the 33 years from 1968 into 2001. Interest rates have risen sharply, but remain lower than levels at which they exerted significant negative influence on the overall economy in the past.

Economic growth responds to changes in monetary policy with a lag. This could mean that all of the tightening that has occurred so far could begin to negatively impact economic growth in coming quarters.

Monetary authorities plan to slow or pause their rate hikes as they assess the impact of past policy tightening should this emerge. That said, monetary tightening already has been asserting itself on inflation and prices for more than a year, suggesting that the lag in the economic effects of rising interest rates may not be a real lag: If interest rates have affected inflation over the past year, that may signal that monetary policies’ effects on overall economic activity has already been being felt, and it has not had a major negative effective on business investments, consumer demand for non-interest rate sensitive goods and services, and employment. Many other factors are at work on these economic trends, including the growing international trade hostilities, perhaps offsetting any negative economic pressures from the rise in interest rates. Monetary authorities set out on their policy tightening cycle with the primary objective of bringing inflation, which had reached multi-decade highs, down to their target levels. The process of inflation softening has started. For inflation to continue softening, economic growth might need to slow.

As mentioned before, this slowing economic growth is expected to occur due to past monetary policy tightening. There are a few ways in which future trends in inflation and economic growth could play out. In an ideal scenario, economic growth slows just sufficiently to reduce inflation rates further but does not precipitate a recession.

In a less ideal, but more likely, scenario economic growth slows to a level that would be considered a shallow recession, which helps lower inflation. Such a recession would be expected to be short and shallow. Markets seem to be pricing in this scenario as well, based on their expectation of a Fed interest rate cut in May 2024. Markets have been repeatedly wrong about the level of interest rates and the timing of any rate reduction, however.

Finally, there is a third scenario that could play out, which is a continuation of the current trends in inflation and economic growth, where inflation is declining and economic growth is strengthening. If this situation continues, real wages will rise, increasing consumer purchasing power and possibly pausing the decline in inflation or even causing it to increase. In this scenario strong economic growth would delay any recession, but the Fed would need to tighten policy further to quell inflation, which could result in a delayed but deeper recession along the lines of what CPM has been projecting in recent years.

Also, besides monetary policy there are macroeconomic (fiscal policy), political (both domestic as well as international), and other factors (supply and demand side issues) that will influence economic growth and inflation. Monetary trends may take a back seat to all of these factors.

The lack of clarity regarding the direction for inflation and economic growth could keep markets volatile in the coming quarters, which should provide support to gold and silver as portfolio diversifiers. That said, the precious metals markets pass through a period of seasonal weakness during the summer months, which could act as a headwind to their prices in the near-term.”