Economic Outlook – 29 January 2023

The Bureau of Economic Analysis put out its first estimate of Q4 GDP growth. The economy reportedly expanded 2.9% annualized in the quarter, a bit more than the median economist forecast calling for a +2.6% print. This gain hoisted economic output 5.1% above its pre-COVID level and reduced the output gap to only 0.5%. Domestic demand weakened in the three months to December as gains for personal consumption (+2.1% QoQ annualized), intellectual property (+5.3%), and structure investment (+0.4%) were offset in part by declines for equipment (-3.7%) and residential investment (-26.7%). Government spending (+3.7% QoQ annualized) contributed to growth in the quarter. As expected, households continued to redirect consumption from goods (+1.1% QoQ annualized) to services (+2.6%). Spending on the latter thus move further above its pre-pandemic level. Trade once again had a positive impact on growth (+0.56 percentage point) but this time only because imports (-4.6% QoQ annualized) declined at a faster pace than exports did (-1.3%). Inventories, for their part, added a whopping 1.46 percentage points to the overall growth figure GDP growth came in stronger than expected in Q4, but this was due in good part to inventory build-up, which should reverse in the coming quarters. Trade also contributed to the headline figure but only because of a steep drop in imports, which reflected a slowing of domestic demand. Final sales to domestic purchasers, a good gauge of the underlying strength of an economy, expanded just 0.2% annualized in the quarter. Outside of the pandemic, this was the weakest print since 2009Q4 Overall PCE inflation decelerated from 5.5% year-on-year to 5.0% in December. The Fed’s preferred inflation measure, core PCE, slowed to 4.4%. Encouragingly, the 3-month annualized change on core PCE came in at 2.9% – a notable deceleration from the 5% pace seen during summer and early autumn. All in all, things appear to be moving in the right direction on this front. This is the last major inflation reading before next week’s FOMC decision Durable goods orders grew 5.6% in December, far more than the 2.3% expected by consensus. Orders in the transportation category jumped 16.7% on increases for civilian aircraft (+115.5%), and vehicles and parts (+0.7%). Excluding transportation, orders dipped 0.1% after edging up 0.1% in November. The report showed, also, that orders for non-defence capital goods excluding aircraft (a proxy for future capital spending) decreased 0.2% MoM after stagnating in November. On a three-month annualized basis, “core” orders growth sagged from 1.1% to 0.1%, which nevertheless continues to suggest that business investment in machinery and equipment did not worsen in Q4 Private fixed investment deteriorated considerably last quarter, down at a -6.7% annualized pace, following a 3.5% drop in Q3. Most of the weakness continues to come from residential investment, which plunged another 26.7%, and follows drops of 27.1% and 17.8% in Q3 and Q2, respectively. Hard hit by the sharp rise in mortgage rates, residential investment has now declined for seven consecutive quarters, with most of the drop concentrated in single-family construction. Business fixed investment eked out a 0.7% annualized gain, which was largely concentrated in intellectual property investment. Equipment spending declined at a 3.7% annualized pace, with the weakness tied to investment in information processing equipment specifically Sales of new homes rose 2.3% to 616K (seasonally adjusted and annualized) from November to December. This third straight monthly gain flew in the face of the consensus forecast calling for a decrease to 612K. New-home sales nonetheless remained 40.5% short of their pandemic peak. The monthly increase was accompanied by a stabilization in the number of homes available on the market (flat at 461K). Still, as sales increased more than supply did, the inventory-to-sales ratio sank from 9.2 to 9.0, which remained high historically The S&P Global Flash U.S. Composite PMI clocked in at 46.6. This is better than the 45.0 registered in December but it still reflected a marked contraction in private-sector activity (the indicator was stuck in contraction territory for the seventh straight month). The new orders sub-index remained subdued in the month though it showed some improvement over its past few readings. As a result, work backlogs continued to shrink. Employment remained in expansion territory in the month, although the pace of growth was not especially solid. In a reversal of the recent trend, input price inflation accelerated. Polled businesses continued to report that “inflation, interest rates and customer hesitancy” weighed on their activity The index of leading economic indicators (LEI) declined 1.0% in December to a 21-month low of 110.5. Eight of the ten underlying economic indicators acted as a drag on the headline index, with the biggest negative contributions coming from ISM New Orders (-0.23 pp), average consumer expectations (-0.19 pp), and jobless claims (-0.18 pp). Orders of non-defence capital goods ex aircraft, on the other hand, contributed 0.02 pp to the headline figure. Historical analysis shows that an annualized drop of 3.5% in the LEI index over six months, coupled with a six-month diffusion index below 50%, is generally symptomatic of a pending recession. These conditions were present in December: The index dropped more than 5% annualized over six months and the six-month diffusion index stood at 27.5% Initial jobless claims fell from 192K to a nine-month low of 186K in the week to January 21. Continued claims, for their part, edged up from 1,655K to 1,675K As policy makers continue to deliberate over raising the debt ceiling, the Treasury Department decided to stop fully funding the Government Securities Investment Fund of the Thrift Savings Plan — a fund that allows government employees to invest in interest-bearing US securities as part of their retirement savings — the latest of several extraordinary measures to avoid breaching the debt limit. According to Treasury Secretary Janet Yellen, the United States has until June of this year before it defaults on its debt. Congress has either raised the debt ceiling or revised the definition of the debt limit 78 times since 1960, so this is a re-occurring issue that tends to emerge every couple of years or so. While negotiations may drag on for some time, Congress stresses that the US will not default Fed Vice Chair Lael Brainard is being considered as the top contender for the head of the National Economic Council position to guide President Biden in key economic policy items, including debt limit negotiations, the antitrust agenda and US energy policy. Brian Deese, the current director of the National Economic Council, is planning to step down, though a definitive date has not been announced. Biden is expected to make a final decision in the next several weeks Stocks resumed their winning streak, as investors appeared to welcome some hopeful signals that the economy might skirt a recession in 2023. Consumer discretionary stocks were especially strong, thanks partly to a big jump in Tesla shares over the week following a favorable outlook from CEO Elon Musk. The typically defensive consumer staples, health care, and utilities segments lagged. Relatedly, value stocks underperformed growth shares. The strong start to the week on Monday was due in part to an article over the weekend by Nick Timiraos, a Wall Street Journal reporter known as the “Fed Whisperer” for accurately predicting previous turns in Federal Reserve policy. Timiraos cited recent comments from Fed governor Christopher Waller, previously an advocate for aggressive rate hikes, in which he highlighted “ample evidence” of slowing demand and said that he would support a quarter-point rate increase at the Fed’s next two-day policy meeting concluding February 1 In terms of data release, consumer confidence is out on Tuesday. Key to understanding the impact of labor on the consumer mindset is the Conference Board’s consumer confidence measure. Unlike its counterpart gauge from the University of Michigan, which tends to reflect the impact of inflation, the consumer confidence index tends to reflect labor market dynamics in a more pronounced way. This explains why the Michigan sentiment measure fell to an all-time low in June 2022, while the Conference Board’s consumer confidence never came even within 60 points of its lows plumbed during the financial crisis in 2009 ISM Manufacturing is out on Wednesday. The manufacturing sector appears to be already in recession. This week’s durable goods report showed a pivot from capital goods orders merely slowing to posting outright declines. Taken in tandem with the contraction in equipment spending in this week’s GDP report, this is further evidence that the manufacturing recession may be under way  

The UK’s composite PMI in January has registered at the lowest level for two years, falling from 49 in December to 47.8. This registered well below expectations of 48.8 and indicates a contraction in activity. Activity in the services sector, which accounts for around four fifths of the UK’s economy, dropped to a 24-month low in January at 48, down from 49.9, while the manufacturing PMI saw an improvement, rising from 45.3 to 46.7. Lower volumes of private sector activity have been attributed to a squeeze on household incomes and greater risk aversion among corporate clients There are, however, some bright spots in the survey. This latest survey shows that input cost inflation is easing. While wage pressures continue to increase business expenses, this is often being offset by lower fuel bills, commodity prices and shipping costs. Moreover, business expectations for the year ahead have improved considerably with higher levels of confidence being observed in both the manufacturing and services sector. The latest reading shows the strongest optimism for eight months   

ECB President Christine Lagarde, Knot, and fellow Governing Council member Ollie Rehn repeated their recent calls for “significant” rate increases in February and March. However, Executive Board member Fabio Panetta stated there was too much economic uncertainty to unconditionally pre-commit to a specific policy course beyond February. He added: “Inflation is still too high, but recent developments suggest that we can fend off the risks of second-round effects and bring down inflation by continuing to adjust our policy rates in a well-calibrated, non-mechanical way.” The Eurozone flash Composite PMI rose above expectations to 50.2 in January, compared with 49.3 the previous month. The Manufacturing PMI rose to 48.8, compared with 47.8 earlier, and the Services PMI rose to 50.7, compared with 49.8 the month before. All three statistics were above expectations. France’s economy saw its third monthly decline in private sector output, driven by lower goods production and a sustained weakening in the service sector. Still, the aggregate rate of contraction was marginal, suggesting that the country’s economic downturn remains relatively modest so far. Meanwhile, the German services sector returned to growth, but the manufacturing sector fell further into contraction. The January survey continued to highlight multiple headwinds to demand, including high inflationary pressures, tightening financial conditions, low appetites for investment, and, inventory reduction in manufacturing, which altogether led to a further broad-based fall in inflows of new orders Under the hood of the headline eurozone PMI indices, estimates of future output improved but remain below the historical median. Notably, there were also falls in input prices, albeit these have remain historically high in the services sector. Altogether, measures of price pressures (including supply disruptions) continued to fall and have now come down to historical averages, except in France where they remain on the high side. There were also improvements in new orders as well as new export orders, although these remain historically low in the manufacturing sector. Employment growth saw marginal increases as well Shares in Europe rose as some encouraging economic data points helped to overcome concerns about the pace of monetary policy tightening. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 0.67% higher. Major stock indexes also advanced. Italy’s FTSE MIB Index gained 2.56%, France’s CAC 40 Index climbed 1.45%, and Germany’s DAX Index added 0.77%    

Shipping cancellations at China’s largest ports have increased amid weaker overseas demand. Cancellation rates from Asia are estimated to reach 31% over the coming weeks, compared with 23% last year and 16% in 2021, the Financial Times reported, citing supply chain data provider Drewry. While cancellations around the Lunar New Year are normal, this year’s rate will be “exceptionally elevated” as external demand wanes. China’s exports have declined for three consecutive months due to pandemic-related disruptions across the country and softer external demand as many economies have slowed. Although Beijing rolled back pandemic restrictions in December, rising infections continued to disrupt activity Total box office sales reached RMB 3.62 billion, ahead of sales reported in the prior-year period and above pre-pandemic levels. Meanwhile, outbound air tickets more than quadrupled for the full year, while hotel bookings doubled. The offshore gambling hub of Macau received more than 71,000 visitors from mainland China and Hong Kong on Monday, marking the highest one-day total since the start of the pandemic. Spending by Chinese consumers is expected to remain restrained in the near term as the country recovers from three years of pandemic restrictions. Household bank deposits grew by a record RMB 17.8 trillion in 2022 as the pandemic kept people home, according to China’s central bank. Some analysts have estimated that as little as RMB 1.5 trillion will be spent on consumption, which could keep a lid on the economic recovery Financial markets in mainland China were closed for the Lunar New Year holiday, which started January 21, and will reopen on Monday, January 30. The Hong Kong stock exchange resumed trading on Thursday, and the benchmark Hang Seng Index gained 2.96% for the holiday-shortened week. China’s domestic activity picked up significantly during the weeklong holiday, fueling optimism about a faster-than-anticipated economic recovery as people enjoyed the break from pandemic restrictions. Approximately 95.9 million trips were taken via road, rail, air, and waterways in the first four days of the holiday, or a daily average of 24 million trips compared with 18.6 million over the 2022 break, according to Ministry of Transport data    
Sources: T. Rowe Price, MFS Investments, Wells Fargo, TD Economics, Handelsbanken Capital Markets, National Bank of Canada, M. Cassar Derjavets