Equity markets posted strong returns last week. The S&P 500 Index advanced a healthy 2.48%, and growth stocks drove the NASDAQ Composite a robust 4.32%.1
As the financial markets focus on the upcoming Federal Reserve meeting on February 1, recent economic data will provide insight for Fed officials as to how successful their hawkish monetary policy has been in slowing the economy to control inflation. However, any good news surrounding the strength of the economy could end up being bad news if it forces the Fed to re-evaluate the pace of interest rate hikes.
Q4/22 US GDP data released last week showed growth running at a stronger-than-expected 2.9% pace. However, beneath the headline data it was evident that measures of underlying demand, such as consumer spending and business investment, were relatively weak2. Expectations are for slower GDP growth in the first and second quarters of 2023.
Meanwhile, Commerce Department data released on Friday showed that the Fed’s preferred inflation measure, the Personal Consumption Expenditures (PCE) Index, eased in December to 5%, its slowest annual pace in over a year. Prices for services, up 5.2%, rose faster than prices for goods, up 4.6%. Ex food and energy, the PCE Index increased 4.4%.3 Despite the positive trajectory of the data, they are still well above the Fed’s 2% goal and the “stickier” services sector, which includes housing and health care, a concern.
Within the same release, personal spending in the US slipped 0.2% in December4, worse than market forecasts of a 0.1% decline. The data indicate that consumers lost momentum at the end of the year, weighed down by high prices and elevated interest rates.
The Fed is also concerned about the strength of the labor market. With the unemployment rate at 3.5%, the economy is in essence at “full employment”. However, the Fed would welcome any slack in the economic data, such as initial jobless claims or non-farm payrolls. Despite anecdotal examples of layoffs at firms like Amazon, Microsoft and IBM, we have yet to see this slack appear in the aggregate data. “Until the employment situation weakens, the Fed will have trouble declaring ‘mission accomplished’ – especially with solid GDP data.”5
The Fed’s hawkish stance has many economists worried the central bank will go too far: Bloomberg’s US Recession Probability Survey currently foresees a 65% chance of a recession over the next year.6 However, several officials still maintain that a soft landing – a scenario in which inflation cools without a surge in unemployment – is possible.
Thank you for your continued confidence in our team,
Asset Management Department
Sequoia Financial Group