Here are 3 reasons why Jefferies sees a policy rate above 4% through the end of 2023 and a resilient US economy

Stocks extended their losses on Monday after Federal Reserve Chairman Jerome Powell’s speech in Jackson Hole on Friday indicated that the central bank planned to continue raising interest rates to curb inflation, even if it caused “some pain” for American households.

As Powell’s blunt speech heightened fears on Wall Street about the central bank’s potential tolerance of a recession, economists at Jefferies expect the US economy to remain strong even as the Fed pushes rates to 4% and keep them there throughout 2023.

The Dow Jones Industrial Average DJIA,
fell 51 points, or 0.2%, to 32,232 on Monday afternoon, after dropping more than 1,000 points on Friday and having its worst day since May. The S&P 500 SPX,
was down 7 points, or 0.2%, at 4,051. The Nasdaq Composite COMP,
fell 58 points, or 0.5%, to 12,083.

See: Stocks head for more pain as 3,900 becomes a new line in the sand for the S&P 500, chart watchers say

“We believe the Fed and continue to believe it will push rates to 4% and hold them for all of 23 year,” wrote Aneta Markowska, chief economist, and Thomas Simons, money market economist at Jefferies in a note from Friday. “We think rates will be higher for longer because the economy will be stronger for longer.”

“In our view, the risk of a recession over the next 6-9 months is much lower than expected. To be clear, we do not believe in a soft landing scenario; we believe the Fed will eventually forced to cause a recession in order to reduce wage growth and bring inflation down to 2%,” the economists said. “However, bringing the economy down will be more difficult and will take longer than expected.”

According to Jefferies, three narratives are now fueling recession expectations. Here are the reasons why they disagree with all three.

Margin expansion and positive cash flow in second quarter won’t trigger layoffs

Many investors worry that companies will respond to high inflation and weak productivity in the first quarter by cutting staff, but economists at Jefferies said companies, so far, have been able to pass those costs on to consumers and that the margins in the second quarter increased quite significantly.

“National non-financial profits, which drive future hiring and investment decisions, rose 9.4% quarter-over-quarter on a pretax basis,” Markowska and Simons wrote. “Employee compensation, which accounts for about two-thirds of the company’s cost structure, rose 2% quarter-over-quarter, but net revenue rose even more, by 3.3% . This resulted in margin expansion and positive cash flow. » (See table below)


See: The Fed’s Powell triggered a 1,000 point rout in the Dow Jones. Here’s what investors should do next.

Real wages will increase in August; GDP will grow by more than 3% in Q3

Jefferies economists said the narrative that negative real wages will compress consumer demand is “very backward-looking” and ignores that real wages rose 0.5% in July from a month ago.

“Real wages will almost certainly rise again in August, given that the CPI is on track to contract 0.1% month-over-month,” Markowska and Simons said. “With consumers spending less on gasoline, discretionary spending — and real spending — is expected to accelerate.”

Meanwhile, the two economists expect GDP to grow by more than 3% in the third quarter, with net exports likely to be highly additive to growth. “The merchandise trade balance narrowed by $9.5 billion in July and has now completely reversed the widening from November to March. We estimate that real imports fell 2.1% month-to-month. the other last month, while real exports rose 3%. If both remain at current levels through September, trade will add 2-3% to Q3 GDP.” below)


Surveys have become a misleading indicator with little correlation to activity and GDP

Investors look at the soft data to build a Q4/Q1 recession forecast on the assumption that the surveys are a good leading indicator, but Markowska and Simons said they’re getting misleading, given their low correlation to GDP. activity and GDP over the past decade.

“Our soft and hard data indices show that these divergences are systemic and
have been around for a while,” Markowska and Simons said. “Software and hardware data used to evolve together, but have become highly uncorrelated over the past decade.” (See table below)