A strong economy is making the inflation fight difficult
RUSSELL PRICE – CHIEF ECONOMIST, AMERIPRISE FINANCIAL
WEEKLY MARKET PERSPECTIVES — December 05, 2022
The S&P 500® index was 1.1% higher last week while the NASDAQ Composite grew by 2.1%. The Dow Jones Industrial Average was up a modest 0.2% for the week, but it’s a slim 5.3% lower on the year. Through Friday, the S&P 500 is down 14.7% year-to-date and the NASDAQ Composite is lower by 26.7% on a price-only basis.
Equity market gains were fairly broad based last week with only the Energy and Financials sectors seeing declines. The S&P 500 Energy Index was down 2.0% as West Texas Intermediate crude oil prices have trended lower over the last few months. The S&P 500 Financials Index, meanwhile, was down 0.6% on lower interest rates. The Communications Services sector led the way higher with a 3.3% gain and the Consumer Discretionary sector was second with an increase of 2.1%. Since starting the fourth quarter, the S&P 500 has registered gains in six out of nine weeks and grown by 13.6% on a price-only basis. The large-capitalization shares of the Dow Jones Industrial Average have seen a surge of +19.9% since the fourth quarter began while the tech-heavy NASDAQ Composite has grown by a more modest +8.4%.
A strong employment situation conflicts with the Fed’s mandate to control inflation; equity and fixed income markets mixed following the employment report
Last week’s equity market gains came despite another strong Employment Report. Friday’s Labor Department release showed 263,000 net new jobs were created in the month of November versus a Bloomberg consensus estimate of +200,000. More importantly, Average Hourly Earnings (AHE) grew by +0.6%, twice the +0.3% rate expected. Combined with a upward revison to prior month numbers, AHE were up 5.1% from year-ago levels as compared to the 4.6% increase expected.
Under normal circumstances a strong employment report would be welcomed for its positive reflection on employment demand and economic activity. Under current circumstances, however, it conflicts with the Fed’s efforts to moderate demand and lower inflation. Wages are a big part of the inflation equation, and Friday’s release, is a step in the wrong direction. We may need to see a light Consumer Price Index report next Tuesday (December 13th) to solidify a step-down in the Fed’s interest rate hiking cycle. Following recent comments from Fed Chair Powell and other FOMC members, financial market expectations seem to have coalesced in looking for a 50-basis point hike in the fed funds rate next week, down from the 75 basis point hikes implemented after the last four monetary policy meetings. The Fed will announce their decision on Wednesday, December 14.
Equity markets initially responded to Friday’s employment report with a moderate sell-off. Stocks steadily regained lost ground through the day and the S&P 500 ended the session just 0.1% lower. Bond markets appeared less convinced that the strong jobs report would keep Fed officials on track for a 50-basis point hike, but interest rates saw little movement, nonetheless. The yield on the benchmark U.S. 10-year Treasury security ended the week at 3.51%, down from the 3.69% of the prior week. The 10-year Treasury rate starts this week at its lowest level since mid-September and well off its recent high of approximately 4.2% as seen in late October and early November. The U.S. dollar also continued to fall last week. The ICE U.S. Dollar Index was down 1.4%, leaving it 8.4% lower than its September 27th high. Overall, the Index is still 8.9% higher on the year and still higher than at any other point from December 2002 through June 2022.
International markets were mixed last week with China related shares seeing the most notable movement. Chinese leaders indicated a softening of its stringent COVID-19 rules late in the week thus sending Hong Kong’s Hang Seng Index up 6.3% and China’s main CSI 300 Index up 2.5% on the week.
Strength in the second half of 2022 could impact economic growth in 2023; recession odds sit just above 50% for next year
Updating our economic outlook. The Commerce Department also upgraded its assessment of Q3 real Gross Domestic Product (GDP) growth last week, lifting its reported growth rate to +2.9% from an initial +2.6%. Early data for the current quarter (Q4) suggests another solid pace of advancement. Following recent reports on Personal Spending, Construction Spending, Business Investment, and an advance report on Trade for the month of October, our real GDP forecast for Q4 now stands at +3.0% versus our prior estimate of +2.4%. By comparison, the Atlanta Fed’s GDPNow estimate is currently +2.8%.
As was the case last year, strength in the second-half of 2022 could pull-forward some growth from the first-half of 2023. As such, with the Commerce Department’s upgrade to Q3 and the boost to our Q4 forecast, our estimates for the first two quarters of 2023 have declined slightly. We now see Q1-2023 real GDP at -1.0% versus a prior estimate of -0.8% and Q2 at -0.6% versus a prior -0.5%.
Will it be a recession? This year we had two consecutive quarters of negative real GDP growth and it was not a recession. Will that be the case again? We believe the designation, relative to actual conditions is inconsequential, but we currently see the odds of economic conditions meeting the National Bureau of Economic Research’s (NBER) definition of recession over the next year are just over 50%.
However, an official recession designation could be avoided if most of the pressure on real GDP in the first-half of 2023 once again comes from fluctuations in trade and inventories. Without material declines in key economic categories such as consumer spending, employment, business investment and /or industrial output, we believe the NBER would be hard-pressed to label the period an official recession. (The chart to the left is sourced from American Enterprise Investment Services Inc.)
The week ahead: The economic release calendar is a bit slower this week but still offers reports on services activity on Monday, international trade on Tuesday, consumer credit on Wednesday and the Labor Department’s report on Producer Prices on Friday. There are also a number of key releases internationally as well.
Further, investors will be closely watching energy markets this week. The European Union’s self-imposed ban on Russian crude oil imports is scheduled to go into effect on Monday. Western national will also try to implement a ceiling on Russian crude oil prices. Though the ban has been planned for months, implementing both the cut off and the price cap holds the potential to disrupt global energy commodity trade flows, which could cause price swings.