Strong data complicates Fed's goal to slow inflation - Economic & Financial Markets Monthly Review | February 2023

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Strong data complicates Fed's goal to slow inflation - Economic & Financial Markets Monthly Review | February 2023
Economic & Financial Markets Monthly Review   | February 2023

Strong data complicates
Fed’s goal to slow inflation
Strong data complicates Fed's goal to slow inflation - Economic & Financial Markets Monthly Review | February 2023
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
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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

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