Two the Point — Recession or No Recession? Inflation Holds the Key

Market Insights in Two Minutes – Inflation holds the key to the near-term direction of the economy…and likely the stock market. If inflation does not begin to show signs of easing, the Federal Reserve (Fed) will be forced to increase interest rates to cool the economy. In the Fed’s eyes, if supply cannot be materially increased to meet demand, demand must be sufficiently reduced to meet supply. This is the only way to restore the balance necessary to reduce price inflation.

So where does that leave us today?

We believe a “soft landing” scenario for the economy is still possible. In fact, we think there are meaningful headwinds to future inflation. The chart below is one example. As supercharged demand cools – stimulus fades, demand shifts from goods to services, and the Fed induces demand destruction – companies have continued to stockpile inventory. Retail inventories are now 8% above the pre-COVID trend.  Inventories are rising relative to sales, often a precursor to slowing inflation.

If inflation has in fact peaked, the Fed will be able to justify a slower pace of monetary tightening later in the year. This will result in a mid-cycle economic slowdown, but not a severe recession. Should inflation remain stubbornly high, the Fed will have no choice but to hike rates until something breaks – either the economy, the stock market, or both. In either scenario, we believe our increased exposure to U.S. large cap growth stocks was a sensible exposure adjustment as investors look for companies that can maintain earnings growth amid an economic slowdown.
Source: Factset; Bryn Mawr Trust

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