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The Current State of the Economy: Inflation, Interest Rates, and the Path to Recession

June 3, 2023

Given the whirlwind of economic activity that's unfolded since March or April, it seems appropriate to delve into some pivotal topics that are shaping our financial landscape.

The Political Theater of the Debt Ceiling

We've witnessed the political chess game surrounding the debt ceiling, and thankfully, it has made its way through the House and is awaiting conclusion in the Senate. Despite the political spectacle, at its core, this all amounts to the government's perennial practice of kicking the can down the road.

It's been decided to postpone the inevitable until January 2025 — the year we anticipate welcoming a new president into office.

The National Debt and Interest Rates

Looming beyond the political theater is our country's towering national debt, standing at a staggering $32 trillion, with the specter of a $34 trillion debt by 2025. This translates to an overwhelming $250,000 per taxpayer.

With this comes the undeniable reality that interest expenses, alongside entitlements such as Social Security and Medicare, may soon consume our entire budget, leaving no room for discretionary spending.

The Federal Reserve's Actions

Turning our focus to the Federal Reserve, we've seen interest rates surge to 5-5.25% — the most significant rate increase in the history of the institution. These increases have had a tangible effect, notably on the housing market, with mortgage rates climbing to 7% and used auto loan rates skyrocketing to nearly 14% for individuals with exemplary credit scores.

This tightening is an attempt to rein in inflation, which peaked at around 9% last year but has since declined to about 5%.

The Inverted Yield Curve and Recession Signals

Economic indicators, such as the inverted yield curve, suggest that a recession may be imminent. An inverted yield curve occurs when short-term interest rates exceed long-term rates, signaling high immediate inflation but predicting slower growth — hallmarks of an impending recession.

Coupled with record consumer debt and a decline in home sales, it's clear the economy is slowing as intended, reducing demand for goods and services.

Employment as The Last Stand

Despite these indicators, employment remains robust at a 3.5% unemployment rate. However, for inflation to truly be brought down to the Federal Reserve's 2% target, unemployment would likely need to rise above 4.5-5%, bringing about a difficult but necessary adjustment period.

Banking Systems and Credit Markets

Recent troubles within the banking sector, including the failures of institutions like Silicon Valley Bank, have exacerbated concerns. Regional banks, responsible for a significant chunk of commercial lending, are now in a precarious position, tasked with shoring up their balance sheets amid a tightening credit environment.

The corporate credit market might soon feel the impact as companies face the prospect of refinancing at much steeper rates.

The Market's Mixed Signals

Regarding the stock market, the year has proven challenging. The exuberance surrounding technology and AI has led to disparities, with the top seven stocks in the S&P 500 faring well, while the broader market has remained relatively stagnant. Still, there are safe havens available, including treasury bonds and money market funds offering solid returns.

Protecting Your Financial Future

As always, the priority remains to safeguard your investments. In these volatile times, it's crucial to stay informed and be ready to pivot as necessary. If you have any questions, concerns, or thoughts, don't hesitate to reach out. Until next time, stay vigilant, and God bless.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult with your financial advisor.
© Copyright 2023 | Reyes Financial Architecture, Inc. | All Rights Reserved | Firm Disclosures
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