Economic Update Winter 2023

The U.S. economy remains in a late-cycle expansion phase with broad concerns of a recession. The Federal Reserve rate hikes have not had enough time to impact economic growth yet. Companies are laying off workers, however there are still plenty of jobs available. Unemployment is incrementally rising, and consumer spending for the moment is holding up. A significant rise in unemployment is the telltale indicator of every recession. The economy is far off from unemployment levels found in a recession. There is hope that any recession will be a mild and short-lived because unemployment may not reach a level normally associated with a recession.

The GDPNow estimates real GDP growth last quarter at 4.1% - strong expansion figure. However, a variety of recession indicators are signaling a recession is coming. The Yield curve has inverted, notably in the most reliable part, 3 months – 10 Years, which signal a recession ahead. The ISM’s Services Index, another fairly reliable recession indicator, is in contraction territory now. Leading Economic indicators (LEI), a composite of economic activity that leads the economy, were down about 5% year-over-year. All previous declines of that magnitude since the 1950s have ended in recession according to The Conference Board. Similarly, the ratio of leading indicators to lagging coincident indicators peaked and rolled over. That too is a strong indicator of a looming recession.

The Fed, as expected, hiked 50 basis points again, it also boosted its rate target for the next year to 4.94%. It’s now at a 15-year high of 4.25% to 4.5%. Its mission in 2023 is to prevent inflation from becoming embedded in the economy. To do that the Fed believes it must create conditions for sufficient job layoffs which in turn should soften wage pressure and consumer demand thereby driving inflation down.

Overall inflation has peaked. Inflation has declined for six straight months. CPI rose 6.5% from a year ago, lower from its peak of 9% last year according to the Labor Department. Many components of inflation have peaked and are rolling over: Commodity, Goods, Wage, Rent. It's the service sector inflation that seems stickier. One Year Treasury Inflation Protected Bonds (TIPs) imply the Fed will be successful in lower inflation over the next year – TIPs 1-Year Expected inflation rate is 2.67%. The Producers Price Index (PPI), a leading indicator for inflation, declined from a peak last March of 11.7% to 8.0% Y-O-Y. ISM Services in contraction means inflation has peaked, earnings should decrease, and lower economic growth is headed our way.

The Labor market remains resilient in the face of an onslaught of rate hikes. Initial Jobless Claims is bouncing at very low levels not associated with even a slowing economy let alone a recession. December’s Job’s report shows the economy is moving in a slow growth path not a contraction. Moreover, wages grew slower than expected, supporting a developing trend of lower inflation pressure. Wage growth in December fell to 4.6%. The Federal Reserve believes it must fall below 4% for inflation to drop towards its goal of 2% PCE inflation.

For now, the U.S. economy is in its Late cycle phase characterized by Fed tightening financial conditions to curb inflation, tighter credit conditions, slowing sales, and rising inventories.