Still Unprecedented

What a difference a year makes!

One year ago the Federal Reserve was forecasting that real GDP would grow a strong 4.0% in 2022, that PCE prices would be up a relatively moderate 2.6%, and we should expect a grand total of three 25 basis point (bp) rate hikes by the end of the year.

Instead, it looks like real GDP will be up about 0.5%, PCE prices will be up 5.6%, and we had the equivalent of seventeen 25 bp Fed rate hikes, finishing the year at 4.375%. So, if you feel a little dizzy about all of this, imagine how the Fed feels.

For 2023, the Fed is forecasting another year of 0.5% real GDP growth, inflation of 3.1%, and the unemployment rate rising to 4.6%. As for Fed policy, the dot plot shows another 75 bps of rate hikes in 2023, and no planned cuts.

We think growth will undershoot the Fed’s forecast in 2023. Instead of growing 0.5% in 2023, we expect real GDP will shrink about 0.5%. Meanwhile, we think inflation will overshoot: ending next year above 4.0%. Sure, inflation moderates in 2023, but not as much or as fast as many expect.

What does that mean for the Fed? While others obsess about short-term interest rates, we still think investors (and the Fed) should pay more attention to the money supply, M2 in particular. M2 surged in 2020-21, hitting a peak of 27% year-over-year growth and rising a cumulative 40%. But in the past year, M2 growth hit a wall, and is up just 1% from a year ago. If accurate, this means economic activity is likely to slow very sharply – and soon.