Does Newton’s Law of Inertia Apply to Economics?

Does Newton’s Law of Inertia Apply to Economics?

June 11, 2024

The challenge with managing inflation is that there are no brakes. Nothing can make inflation “stop on a dime” and then resume at a nice, predictable two-percent annual rate. Policymakers can only guide inflation to pursue a desired outcome.

When our Federal Reserve moved to slow inflation during the past two years, it raised short-term interest rates.

But now that those tools appear to be showing signs of working, investors are starting to wonder when the Fed may adjust its approach to engineer a “soft landing.”

(A soft landing is when the Fed raises interest rates to slow inflation but stops short of having the economy slip into a recession.)
As you can see from the accompanying chart, the Atlanta Fed’s GDPNow Q2 GDP forecast has dropped from more than 4 percent in mid-May to below 2 percent in early June. It’s bounced up a little, but trending lower.1

Pro Tip: The advanced estimate for Q2 gross domestic product will be released on July 25 by the Bureau of Economic Analysis.2

In short, that's good news. It means the economy continues to grow despite higher interest rates. It also means Jerome Powell & Co. might have some flexibility to adjust interest rates, which could affect everything from mortgage rates to credit cards.

But when I see the GDPNow chart, I’m reminded of Newton’s first law: an object in motion will stay in motion unless acted upon by a force. In this instance, the force that needs to act is the Fed. My expectation is that The Fed will make some moves by the end of the year to help manage GDP’s trend. When that happens, I’ll let you know what it means for the financial markets and your portfolio.

1., June 7, 2024
2., May 30, 2023