Year to date, the markets have made a momentous run despite mixed sentiment about an imminent recession and fear of a Fed that has no reason to turn away from their hawkish stance regarding monetary policy. Recent GDP data is the latest sign that the economy has proved more resilient than expected in the face of substantially higher borrowing costs.
The economy expanded 2.9% on an annualized basis in the final quarter last year, slightly higher than forecasts of a 2.6%. The figure marks a slowdown from 3.2% in the third quarter, reflecting the impact the Fed has made to dampen demand. Even though the labor market remains robust, with unemployment hovering at a multi-decade low and jobless claims falling to a multi-month low, concerns are rising about the outlook for the economy.
As disinflationary forces have manifested from global monetary tightening, market participants have shifted their attention away from price inflation which has shown obvious signs of peaking, to the possibility of recession as 2023 develops. It’s hard to make a case for a recession as long as the combination of both the labor market and productivity remain positive. However, taking the consistency of the credit market as a leading indicator into consideration, the 3-month/10-year Treasury yield curve remains very much inverted.
While GDP and the labor market have yet to break into official contraction, other coincident economic indicators are showing signs of weakness. ISM services new orders index fell by 10 percentage points in December to a contractionary level 45, and the Conference Board leading indicator index fell 1% in December and is now at levels consistent with the previous two recessions of both the pandemic and financial crisis of 2008/2009.
While the Fed is expected to downshift the pace of rate hikes once again to 25 basis points starting next week, the year-to-date euphoria in the equity markets may made fade in the near term. Irrespective of the mixed macro-economic data, the Fed will most likely highlight stable economic output, labor market health, and inflation that remains above the 2% mandated target as a justification to remain hawkish.
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