Economy and Financial Markets Review: February 2023

Dr. David W. Burson

summary

Hard landing, soft landing, no landing? Stronger economic data released over the past month (mostly his January) suggest the economy has started his year strong without slipping into a short-term recession.In addition, inflation accelerated and expectations The Federal Reserve needs to be more aggressive (or at least more persistent) in tightening monetary terms. As a result, financial markets have plunged over the past month, reversing much of January’s stock gains and more than all of his January gains in Treasuries.

economic activity

After months of weakness, consumer spending surged in January. The broad personal consumption expenditure (PCE) measure increased by 1.8% in a month, at its fastest pace since March 2021. Even after accounting for faster-paced inflation (see below), PCE rose 1.1%.and why not? Nonfarm payrolls jumped 517,000 a month, the unemployment rate dropped to its lowest level since 1969 (you’d have to go back to 1953 to find a lower figure), and wages/salaries rose 0.9%. Kei car sales hit an annualized rate of 15.7 million units (the highest since February 2021), spurring an increase in spending.

Lower interest rates during January (more than reversing since then) spurred housing demand. Yields on 30-year fixed-rate mortgages fell to about 6.0% at the end of January after he topped 7.0% in November (from about 6.5% at the start of the year). New home sales rose to 670,000 at an annualized rate, the highest since March 2022, when mortgage rates fell sharply. A pending home sale (signing a contract to purchase an existing home, typically completed 30-60 days after his, and reflected in the National Association of Realtors’ existing home sales figures) is 5 or It jumped to the highest level in the month.

The survey data was mixed, but there were more positive readings than negatives. On the positive side, (1) the ISM’s Services Purchasing Managers Index bounced back to 55.2 in January, reversing the previous month’s puzzling one-month drop below 50 (a number above 50 indicates expansion ). (2) The University of Michigan Consumer Sentiment Index topped 60 in January for the first time since March 2022. (3) The National Federation of Independent Business (NFIB) Small Business Optimism Index rose slightly in his January (although levels were still below average). (4) The National Association of Home Builders housing market index he rose in January (the survey takes place in the first half of each month, but it rose further in February). On the downside, (1) the ISM manufacturing index fell to 47.4, falling below the break-even 50 level for the third straight month. (2) The Conference Board Consumer Confidence Index fell slightly to 106.0.

Based on positive data so far (mostly acknowledged for January), the Atlanta Fed’s GDPNow readings show real growth of 2.8% in the first quarter. This is little changed from the revised down Q4 growth of 2.7%. This growth estimate is subject to change as more complete quarterly data becomes available. If the data for the next two months show stronger or weaker growth, it could possibly change significantly. Slightly above trend economic growth continues despite two of the best recession predictors flashing red. The Conference Board’s Index of Leading Economic Indicators (LEI) fell 5.9% year-on-year in January (a slight improvement from December), the lowest it’s ever been. Moreover, the yield curve is still significantly inverted, with 10-year Treasury yields about 100 basis points below 3-month Treasury yields. The inversion is about 20 basis points smaller than it was a month ago, but he is close to the sharpest inversion since 1981, as the US economy just plunged into its worst recession since the Great Depression. These two indicators have been good predictors of recessions over the past 60 years (the yield curve is longer), and we may be right this time. But still not.

Inflation and the Federal Reserve

A month ago, inflation continued to trend downward and financial markets saw this as a continuing trend. Moreover, the market had expected this slowing in inflation to ease his Fed tightening, leading to a fall in most interest rates and a rise in broad stocks through January. But January’s inflation numbers and his Fed official’s comments changed the market’s view of the Fed, with nearly every inflation indicator higher than expected.

The consumer price index rose 0.5% in January, but the gains pushed the 12-month trend rate down to 6.4%. Core CPI (excluding the volatile food and energy components) rose 0.4% for him over the month, but the trend rate also fell slightly to 5.6% for him. Both monthly increases beat market expectations, leading to a much lower trend growth rate than expected. Importantly, the trend rate is well above his Fed’s long-term target of 2.0% (which uses his broader PCE price index, see below).

The CPI is the most commonly discussed inflation indicator, but the Fed’s focus is on the broader PCE price index, and the inflation news here was a disappointment. Overall his PCE price index jumped 0.6%, well above the previous month’s 0.2% rise. This rise accelerated the trend rate to 5.4%. Core PCE price index also he rose 0.6%. And just like the overall index, trend core rates accelerated (up to 4.7%). Federal Reserve Chairman Jay Powell recently discussed his PCE service (sometimes called a supercore rate), which excludes energy and housing, as a favorable indicator of underlying inflation. , a significant increase from his 4.2% gain the previous month. Not only are these inflation rates well above his Fed’s target, they’re headed in the wrong direction.

Inflation may still be trending downward as the Federal Reserve tightens monetary policy and fiscal policy is no longer expansionary. However, the downtrend is uneven and slower than expected. The market now expects the Fed to tighten monetary policy until the federal funds rate rises to about 5.5% from its current 4.5%. This is about 50 basis points higher than market expectations a month ago. What the Fed actually does with monetary policy will largely depend on how far and how fast inflation falls, and recent data suggest that the Fed is likely to be nearing the upper end of its expected tightening. suggests.

financial market

After a very strong January, with the S&P 500 index up 6.2% and 10-year Treasury yields down 36 basis points, February was a big disappointment. As mentioned earlier, data showing economic strength and steady (if not high) inflation led to a reassessment of his near-term view of Fed policy on the part of financial markets. This revised forecast, in turn, affected both stock and bond prices.

The large-cap S&P 500 Index fell 2.6%, the mid-cap S&P 400 Index fell 2.0%, and the small-cap S&P 600 Index fell 1.4%. The good news about these declines is that the price didn’t give up all of his January gains. Meanwhile, 10-year US Treasury yields rose 40 basis points to 3.92%, the highest level since mid-November. Short-term interest rate gains eased, with the 3-month US Treasury yield rising 18 bps to 4.88%, its highest level since mid-2007.

Rising borrowing rates may be beginning to have a negative impact on credit. U.S. bank card delinquency and credit loss rates continued to rise in January, but remain at historic lows, according to S&P. Still, delinquency rates are back at their highest levels in almost two years. Data from commercial banks, which is only available through the fourth quarter, also shows that delinquency rates for consumer loans and commercial real estate loans are rising. New York Fed data on car delinquencies also show an increase throughout the fourth quarter. But similar to credit card data, commercial and auto delinquency rates remain very low historically. continues and is still at a very low level.

Mortgage delinquencies on unpaid loans are unlikely to be significantly affected by rising interest rates because the floating rate percentage of outstanding mortgage debt is very low. The same applies to loans. However, other debt categories could be significantly impacted by rising interest rates. That is, either the interest rate increases at origination or the interest rate adjusts over time. The more interest rates rise, and the more they stay high, the higher the delinquency rate could be, but of course we’re still starting low. Some of the recent rise in delinquency rates is simply due to the market returning to historically normal levels, but some is due to higher rates, which could increase further in the future.

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Editor’s Note: The summary bullet points for this article were chosen by the editors of Seeking Alpha.