Charts for the Week
January 23, 2023
Mortgage rates | Lower but still high
Last year mortgage rates spiked from around 3% to over 7%, significantly decreasing the affordability and sale of homes. The past few months have offered a slight reprieve as mortgage rates have retreated towards 6% and may have further to fall as they remain at a historically wide spread to the 10-year Treasury rate; however, high mortgage rates are likely to remain a headwind for the sector.
The Federal Reserve is clearly being successful in slowing the economy when it comes to the housing market. In addition, data released last week on industrial production and retail sales in December showed other areas of the economy are weakening as well.
Given the growing signs that the economy and inflation are slowing, investors expect the Fed will increase its target fed funds rate by just 0.25% at its meeting next week and stop raising rates at its following meeting in March.
Inflation | Mission accomplished?
January 16, 2023
Annual inflation as measured by the Consumer Price Index (CPI) declined for the sixth straight month in December, down to 6.4%. Annual core inflation excluding energy and food also improved, declining to 5.7%.
Over the past three months, inflation has been running below 2% on an annualized basis, and core inflation has been close to 3%. As a result of declining inflation and the rapid increases in the fed funds rate by the Federal Reserve, real short-term interest rates based on core CPI eked backed into positive territory in the last quarter of 2022 after being deeply negative to start the year.
Inflation is unlikely to take a straight elevator back down to 2%, but it is definitely moving in an encouraging direction which has alleviated a lot of investors’ concerns even if they remain overly optimistic about how quickly the Fed will stop raising rates and reverse course.
The past few years have highlighted how little is understood about how inflation works, so policymakers are likely to stick to their plans for raising the fed funds rate above 5% for an extend period to ensure that the stake has been thoroughly run through the heart of inflation. If the markets and economy continue to motor along without any great unhappiness, there will be even less incentive for them to do otherwise.
Sources: https://fred.stlouisfed.org/, AOWM calculations
Labor Market | Strong employment, weak wages
January 9, 2023
The labor market remained generally strong in December with the unemployment rate falling to 3.5%. Instead of raising fears that the good jobs report might keep the Fed raising interest rates, investors seized on a slowdown in wage growth as a sign that inflation will continue to abate. While a potentially good sign for inflation, slowing wage growth is likely to add an additional headwind for the economy as wages fail to keep up with rising prices, hurting consumption.
There were also signs under the surface that the Fed is being successful in slowing the economy. The number of new jobs added continued to decline to the lowest level in two years. In addition, the number of employees in temporary help services fell further which has historically been a canary in the coal mine for the broader labor market.
Investors are holding out hope that inflation will subside without a recession. However, state level data through November indicates that more than half the states are already experiencing negative labor market conditions which has historically implied a pending downturn for the national economy. Despite the positive market response to the jobs report on Friday, the odds of inflation retreating peacefully still don’t appear high.
Sources: https://fred.stlouisfed.org/, Federal Reserve, Philadelphia Fed, https://www.stlouisfed.org/on-the-economy/2022/dec/are-state-economic-conditions-harbinger-national-recession
January 2, 2023
2023 | The Outook
Financial markets are coming off their worst year since the great financial crisis in 2008. Last year, fixed income investments suffered their worst year on record as interest rates broke their four-decade downtrend, and stocks suffered their longest prolonged decline in thirteen years. Global financial markets have now shed nearly $40 trillion of their market value.
Policymakers, professional forecasters, and investors remain generally cautious headed into the new year. Nevertheless, the consensus outlook is also the best case scenario where inflation declines steadily, but the economy doesn’t slip into a recession (or at least only suffers a very mild one if it does). Inflation that failed to retreat as expected and/or a recession deep enough to weigh on corporate profits would likely make 2023 another tough year for investors.
With margins still at historically high levels and earnings growth expected to remain strong despite the slowing economy, the potential for disappointing earnings appears to be the biggest risk for the market at the turn of the calendar year.
Sources: https://fred.stlouisfed.org/, Federal Reserve, Bloomberg, YCharts, AOWM calculations