By Gary C. Sanger, Ph.D., CFA
Welcome to 2023! The economic landscape has stabilized somewhat over the past six months, but uncertainty remains high. Except for China, which has oscillated in its health restrictions, the impact of COVID has diminished. Supply chain disruptions are being repaired, and the Fed is beginning to see some success in its battle against inflation. Russia’s invasion of Ukraine continues but the resulting supply chain issues have moderated. According to the Bureau of Economic Analysis, real annualized US GDP rose 3.2% in Q3, reversing declines of –1.6% in Q1 and –0.6% in Q2. Opinions on whether we will enter a recession vary widely. Projections for real US GDP growth in 2023 range from –0.5% to +0.5%, significantly lower than in our last Perspective. Consistent with these forecasts, the Conference Board’s Leading Economic Index was down 1.0% in November, to 113.5, for the ninth consecutive decline. For reference, the index was 112.0 in January 2020. Details in key areas follow below.
Consumers – Despite the Fed tightening and fears of a recession, consumers are still in very good economic shape. The unemployment rate has increased only slightly to 3.7% in November up from 3.6% in June, so labor markets are still tight, supporting higher wages. The Bureau of Economic Analysis reported that personal disposable income rose 0.4% in November, while personal consumption expenditures increased 0.1%. The Federal Reserve estimates that consumers have spent about one-fourth of their excess COVID period savings, so household balance sheets remain in relatively good shape. Importantly, weekly initial jobless claims remain low at 225,000 as of December 29. One notable weak spot in the consumer sector is housing. As a result of Fed actions, the 30-year fixed rate mortgage is near 7% and November sales of existing homes are down 35% from a year earlier. Regarding consumer attitudes, The Conference Board reported that the consumer confidence index rose to 108.3 in December, up significantly from 98.7 in June.
Businesses – Conditions in the business sector are weaker than in the consumer sector. According to the Census Bureau, durable goods orders decreased 2.1% in November following slight increases over the past three months. The Federal Reserve reports that industrial production decreased 0.2% in June but is still 2.5% above its reading a year ago. The US Institute for Supply Management manufacturing index contracted to 49.0% in November, down significantly from its year-ago reading of 60.6%. The ISM services index rose to 56.5% in November, up from 55.3% in June. Compared to a neutral number of 50%, manufacturing is contracting slightly while services are still expanding.
Government – Since March, the Fed has acted aggressively to bring inflation down, raising the Fed funds rate seven times from zero to a range of 4.25% – 4.50% in December. As a result the Fed’s preferred measure of inflation, the personal consumption expenditures (PCE) index declined in November to an annualized rate of 5.5%. This is the fifth consecutive decline from a 40-year high and the lowest inflation rate since October 2021. Of course, fighting inflation also means fighting economic growth. The Fed’s target inflation rate is 2.0%, so more tightening is expected through 2023. Following the Fed’s previous twelve policy tightening cycles since the 1950s, nine have ended in recession. The latest Wall Street Journal survey of economists estimates a 63% probability of a mild recession in 2023. On the fiscal side, Congress passed, and President Biden signed a bill with $1.7 trillion in spending for fiscal 2023. This represents a 5% increase in domestic spending and an 8% increase in defense spending, including aid for Ukraine.
International –The International Monetary Fund’s (IMF) latest World Economic Outlook projects significantly slower global economic growth than their previous Outlook. Global growth is projected to slow to 2.7% in 2023 from 3.2% in 2022. IMF staff cited rising inflation, the resulting tighter monetary policies in Europe and the US and economic damage from the Russian invasion of Ukraine as most responsible for the slowdown. Growth in the Americas, Europe and Asia are all predicted to slow, with an elevated risk of a recession in Europe.
Closing – Overall, economic signals are more mixed than in the recent past. Market uncertainty remains high, so prediction errors will also likely be high. The major uncertainties facing us include the progression of the Russian aggression against Ukraine and the ability of central banks to bring down high inflation without causing a recession. Rising tensions between China and Taiwan, and North and South Korea present additional risk factors for markets.