Strong data complicates Fed's goal to slow inflation - Economic & Financial Markets Monthly Review | February 2023
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Economic & Financial Markets Monthly Review | February 2023 Strong data complicates Fed’s goal to slow inflation
Where is the economy now? The U.S. economy is in the late cycle period with the Fed responding to rapid inflation with a sharp tightening of monetary policy to slow domestic demand. Key leading indicators (including the yield curve) point to elevated recession risks over 2023, especially with the Fed projected to raise rates further at coming meetings. Yield Curve Fed Funds SPREAD BETWEEN 10-YEAR U.S. TREASURY YIELD AND THE FEDERAL FUNDS EFFECTIVE RATE Target Rate 5.00% ‘90-’91 THE GREAT May Rates RECESSION expected RECESSION 5.13% 4.00% 4 2001 RECESSION COVID RECESSION The 10-year/ Feb to climb 4.63% higher in fed funds 3 spread has 3.00% 2023 2 inverted prior 2.00% 1 to every We are here Recession 0 recession in modern 1.00% odds are -1 elevated -2 history 0.00% 1990 1995 2000 2005 2010 2015 2020 Jan Apr Jul Oct Jan Apr Jul Oct 2022 2023 Where we CYCLE END GETTING CLOSER YIELD CURVE INVERSION DEEPENS TIGHTENING CYCLE NEARING ITS END are this The business cycle chart is nearly in recession The 10-year to fed funds spread was negative by The downshift in the size of rate hikes reflects the month territory with the yield curve inversion and the nearly a full percentage point in late January, the Fed's need to more carefully calibrate policy housing downturn being sustained for months. deepest yield curve inversion since late 2000. given its now within a restrictive range. • Key recession signals, including the yield curve • Since at least 1962, a recession has always • But the tightening cycle is not complete yet. What does followed a sustained yield curve inversion that We expect the fed funds rate to rise a further and the Index of Leading Economic Indicators, this mean point to a likely recession over the next year. was at least this deep. 50bps by mid-year — with risks of more hikes given hot job gains and services inflation. • While recent data suggest continued growth in • The inversion reflects the Fed’s rapid increase in the near term, our baseline forecast assumes the policy rate and the bond market's • Fed funds futures are pricing in rate cuts by that a moderate recession hits later in 2023. expectations of an ensuing economic downturn year-end – albeit less than before the strong and slower inflation. January employment report. We see no Fed easing until 2024. 1
Economic Review Labor market is too hot for the economy's own good Job growth was stunningly strong in January and the unemployment rate fell to its lowest level since 1969. While great news under normal circumstances, it can keep services inflation elevated for longer and increases the odds of tighter monetary policy and a recession emerging sometime in the second half. Employment Inflation Core GDP CORE SERVICES EXCLUDING HOUSING ANNUALIZED Q-to-Q GROWTH MONTHLY CHANGE IN NONFARM PAYROLLS 600 7.0% 3.0% 517 500 Job growth 6.5% climbed to a 6.2% 2.0% six-month Services 400 high in 6.0% inflation January remains highly elevated 1.0% Core GDP Showed very 300 5.5% 0.2% little growth in Q4 0.0% 200 5.0% Q3 Q4 Q1 Q2 Q3 Q4 Aug Sep Oct Nov Dec Jan Jul Aug Sep Oct Nov Dec 2021 2021 2022 2022 2022 2022 Where we BLOWOUT JOBS REPORT SERVICES INFLATION REMAINS HOT CORE GDP FLATLINES are this Nonfarm payrolls grew by 517,000 and the A recent favorite of Fed Chair Jerome Powell, Final sales to private domestic purchasers, or month unemployment rate fell to a 54-year low as core services inflation less housing was only core GDP, slowed sharply in 2022 as consumers demand for workers remains extremely strong. slightly below its recent peak. and businesses pulled back on their spending. • Job gains were expected to continue to trend • The cooling of overall consumer inflation has • About half of the overall 2.9 percent annualized What does come mainly from the goods side. Services increase in Q4 real GDP stemmed from an lower in January, but labor demand remained this mean very strong, counter to the Fed's aim to cool inflation tends to be stickier as it is driven by unwanted jump in inventories as consumer and the demand. rising wages and still strong consumer business demand waned. spending on services. • The further tightening in the labor market • Nearly flat core GDP growth implies little indicates upside potential for wage gains that • We expect cost pressures from core services momentum heading into 2023, but strong job could lead the Fed to increase the fed funds less housing to keep inflation elevated (and and income gains in January should support rate above 5.0 percent over 2023. monetary policy restrictive) through 2023. spending activity and growth in the near term. 2
Financial Market Review Stocks rally even as central banks tighten Optimism greeted 2023 with cooler inflation readings boosting investors’ appetite for risky assets. Long treasuries erased some of last year’s plunge, while equity markets posted broad-based increases. Recent central bank actions and the surprisingly strong January employment report suggest a prolonged period of restrictive policy that took some steam out of the equity market at the start of February. S&P 500 10-year Policy Rates Treasury yield OF MAJOR CENTRAL BANKS U.S. Fed Funds Target Rate 5000 5.0% Bank of England Official Bank Rate ECB benchmark policy rate 4500 The 10-year 5.0% 4.0% yield reversed Major much of the 4.0% central 4000 8 out of the 11 3.0% late 2022 rise. banks S&P 500 3.0% continue sectors were to raise 3500 up, adding to 2.0% 2.0% interest a 6% increase rates in January 1.0% 1.0% 3000 Jan Mar May Jul Sep Nov Jan Jan Mar May Jul Sep Nov Jan 0.0% Jan Mar May Jul Sep Nov Jan Where we A NEW YEAR, A NEW MARKET INTEREST RATES RETREAT CENTRAL BANKS TIGHTENING are this The S&P 500 index added over six percent after The yield on the 10-year Treasury note quickly Major central banks continued to lift interest month signs of slowing inflation and expectations that pulled back from year-end 2022 levels on rates higher and signaled that additional hikes an end to the Fed tightening cycle was close. elevated recession concerns for the year ahead. are likely needed to tame inflation. • Investors are more hopeful for a better 2023, • Investors favored long tenor securities with the • The Fed led the way on rate hikes over 2022, but What does two-year yield only modestly lower over with S&P 500 earnings expected to climb nine key global central banks have followed suit in this mean percent this year and futures showing the Fed January. However, yields across the yield response to widespread inflationary pressures. cutting rates in the second half of 2023. curve have climbed higher after the strong employment report. • The brisk headwind of higher interest rates weighs • But the market rally faltered in early February on the global growth outlook for 2023, although as very strong demand for workers ironically • Corporate credit spreads tightened further, the reopening of China and a warmer winter in increases the odds of a hard landing should the extending a three-month easing of credit Europe mitigates the worse case scenario. Fed tighten more. conditions despite looming downturn worries. 3
Outlook Latest Forecast Mixed data reflect an Data as of February 2023 Later 2023 recession economy in transition 2021 ACTUAL 2022 ACTUAL 2023 2024 FORECAST 2025 A moderate recession should occur over the second half of 2023 with weak consumer and business activity likely to carry The mixed economic readings at the outset of the year reflects the Covid-related REAL GDP 5.9% 2.1% 0.7% -0.3% 2.1% into early 2024. crosscurrents that continue to impact the outlook. It is also likely a symptom of an economy in transition, as the numbers often diverge when the growth rate is either UNEMPLOYMENT ramping up or winding down. In this case, the enduring strength in the labor RATE 5.4% 3.6% 4.4% 5.3% 4.8% market is offsetting weakness elsewhere as is typical in the early stages of rate hike cycles. Over time, however, the lagged effects of Fed tightening will weigh on INFLATION job growth as well, reversing the positive feedback loops that are currently (CPI) 6.7% 7.1% 3.8% 2.6% 2.3% sustaining the household sector and, to a large degree, the broader economy. A recession may not be imminent but remains a substantial risk going forward. TOTAL More housing weakness HOME SALES 6.89 5.67 4.60 4.60 5.10 5.50 With mortgage rates high and the unemployment rate Average monthly changes in nonfarm payrolls S&P/CASE-SHILLER eventually rising, demand for 18.9% 6.2%e 0.0% 0.0% 2.5% 3.0% single-family homes should in the first year after the outset of Fed tightening cycles HOME PRICE INDEX remain sluggish — lowering sales, cooling prices, and limiting home construction. The strength of the LIGHT VEHICLE 14.9 13.8 14.6 15.4 16.2 369 labor market is likely to sustain 369 SALES the current expansion 328 326 In the near term FEDERAL FUNDS RATE 0.00% 4.25% 5.00% 3.50% 2.50% Fed easing not likely 281 275 Thousands until 2024 255 5-YEAR After lifting the fed funds rate TREASURY NOTE 1.26% 3.99% 3.70% 3.10% 2.80% to 5.00% (or higher) in the first Current Cycle 198 half of 2023, we expect the Fed to maintain restrictive 166 10-YEAR 1.52% 3.88% 3.60% 3.15% 3.00% policy into 2024 with inflation TREASURY NOTE still above-trend. This could delay the economic recovery from a projected downturn. Mar ‘72 Dec ‘76 May ‘83 Dec ‘86 Feb ‘94 Jun ‘99 Jun ‘04 Dec ‘15 30-YEAR FIXED-RATE to to to to to to to to MORTGAGE 3.11% 6.42% 6.30% 5.00% 4.70% May ‘74 May ‘81 Aug ‘84 Feb ‘89 Feb ‘95 May ‘00 Jun ‘06 Dec ‘18 MONEY MARKET FUNDS 0.14% 2.27% 4.97% 4.09% 2.90% Labor is too hot CLICK HERE HEAR MORE FROM NATIONWIDE ECONOMICS for the Fed 18 min WHEREVER YOU LISTEN TO PODCASTS e = Estimate 4
Contributors Sources Kathy Bostjancic Page 1 | Where is the economy now? SVP & Chief Economist Business Cycle Nationwide Economics Yield Curve Bloomberg; National Bureau of Economic Research Bryan Jordan, CFA Fed Funds Futures CME Group Deputy Chief Economist 2 | Economic Review Ben Ayers, MS Employment Bureau of Labor Statistics Senior Economist Core Services Inflation ex-housing Bureau of Labor Statistics Core GDP Bureau of Economic Analysis Daniel Vielhaber, MA Economist 3 | Financial Markets Review Scott Murray S&P 500 Standard & Poor’s Financial Markets Economist 10-year Treasury yield Federal Reserve Board of Governors Central bank policy rates Bloomberg Ashleigh Leonard Economics Specialist 4 | Outlook Average monthly payroll gains Bureau of Labor Statistics Brian Kirk Latest Forecast Nationwide Economics Communications Consultant Economic & Financial Markets Review | Nationwide Economics The information in this report is provided by Nationwide Economics and is general in nature and not intended as investment or economic advice, or a recommendation to buy or sell any security or adopt any investment strategy. Additionally, it does not take into account the specific investment objectives, tax and financial condition or particular needs of any specific person. The economic and market forecasts reflect our opinion as of the date of this report and are subject to change without notice. These forecasts show a broad range of possible outcomes. Because they are subject to high levels of uncertainty, they may not reflect actual performance. We obtained certain information from sources deemed reliable, but we do not guarantee its accuracy, completeness or fairness. Nationwide, the Nationwide N and Eagle and Nationwide is on your side are service marks of Nationwide Mutual Insurance Company. ©2023 Nationwide NFM-11356AO.3
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