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Too Hot or Too Cold?

The stock market had a tough week as investors vacillated between worries that the economy is too hot, which would lead to more inflation, and worries that the economy is too cold, which would lead to a deep recession. It is difficult to have an economy that is both too hot and too cold, but in today’s pessimistic environment, pundits seem to call for continued high inflation one day, and then a deep recession then next day. So, which is it? Is the economy too hot or too cold? Is it possible to have an economy that is just right?

The Federal Reserve has been battling inflation this year, raising rates in an effort to slow the economy and cool upward pressure on prices. The Federal Reserve thinks the economy is too hot and wants to cool the economy. As a result, markets have been desperately looking for signs that the economy is slowing, inflation has peaked, and the Federal Reserve can end, or at least pause, the interest rate hikes. As we wrote previously, the somewhat counterintuitive result is that ‘good’ economic news could result in falling stock market prices. ( Sure enough, the news this week that November’s non-manufacturing purchasing manager’s index was stronger than expected, normally a positive indicator for the economy, resulted in a drop in the S&P 500 because it meant that interest rate hikes might continue.

However, the stock market fell again on Tuesday over concerns that a recession was inevitable. JP Morgan Chase’s CEO Jamie Dimon said that inflation and its impact on the consumer, “may very well derail the economy and cause a mild or hard recession that people worry about.” Jamie Dimon is worried that the economy is too cold, and that we are headed for a recession.

The Federal Reserve may indeed “engineer” or “cause” a recession in order to get prices under control. However, we are unlikely to see both rising prices and a deep recession at the same time. If the economy falls into a deep recession, as some predict, the result is less spending, lower employment, and falling prices. So which is it? Is the economy too hot or too cold? The inflation numbers will once again be key, and we will see an important indicator on December 13th when November’s Consumer Price Index is released. Of course, it is possible that November’s inflation numbers show that inflation is moderating. If that occurs then we could have the happy result that the economy is neither too hot nor too cold, but just right, with moderating inflation and slow growth. The ‘just right’ scenario is rarely discussed on the news, but if we see it, could result in a relief rally going into the end of the year.


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