Growth
The economy grew at a 2.0% annualized rate in 1Q23, a deceleration compared to last quarter’s 2.6% pace. Consumption, exports and government spending all looked strong, growing at annual rates of 4.2%, 7.8% and 5.0%, respectively. However, most of the consumption gains can be attributed to a strong January. These gains were partially offset by decreases in private inventory and residential fixed investment. Notably, a sharp decline in equipment spending indicated a slowdown in business investment spending. Looking ahead, normalizing inventory levels should support growth, but a strained consumer, tighter lending conditions and weaker business spending remain headwinds in the coming months.
Jobs
The May Jobs report highlighted continued momentum in the labor market, but divergent results from the household and establishment surveys warrant some skepticism toward the strong headline figures. Nonfarm payrolls rose by a stronger than expected 339K, while upward revisions to March and April helped strengthen the report. That said, the household survey looked weaker, as the number of employed people fell by 310K and the unemployment rate rose to 3.7%. Wage growth continued to moderate from its peak, rising by 4.3% y/y. Overall, recent data suggests that the labor market is softening and inflation is still easing. As such, this report should not change the Fed’s plan to pause in June.
Profits
The 1Q23 earnings season has delivered better than expected results, reflective of the success that companies have had in defending margins. Our final estimate for 1Q23 earnings per share is $52.54, representing y/y growth of 6.4% and q/q growth of 4.3%. In total, 70% of companies beat earnings expectations, while 66% beat revenue expectations. Importantly, profit margins bounced to 11.7% during the first quarter, while revenue growth was the largest contributor to earnings. Looking ahead, recession risk is still rising and analyst estimates for earnings likely remain too high, making it difficult to be overly bullish on equities right now.
Inflation
Inflation continued to decelerate in May, with headline CPI rising by 0.1% m/m and 4.0% y/y, its lowest level since March 2021. Core inflation held steady, rising by 0.4% m/m for a third consecutive month, and 5.3% y/y. Gasoline and electricity prices fell by 5.6% and 18.5% m/m, respectively, which helped ease headline inflation, while stickiness in shelter, used cars and transportation services kept core inflation firm. However, the recent decline in the Manheim Used Vehicle Index suggests that used car prices should ease in the coming months. Similarly, headline PCE eased to 0.1% m/m while core PCE looked firm at 0.3% m/m. Overall, this report confirmed that the disinflationary trend is still intact, and y/y headline CPI could fall below 3.5% by the end of the summer.
Rates
For the first time since January 2022, the FOMC voted to leave the federal funds rate unchanged at a range of 5.00%-5.25% at its June meeting. While this pause was largely expected, the statement language and press conference commentary were decisively hawkish, suggesting that another increase is to be expected. The updated Summary of Economic Projections and dot plot were also surprisingly hawkish, with the median FOMC member anticipating two more hikes this year. While we do not think further tightening is necessary, the Fed made it clear that they need further evidence that inflation is swiftly decelerating.
Risks
- Banking sector turmoil could result in tighter lending standards, posing a drag on economic growth.
- An overly aggressive Fed could push the economy into recession.
- Markets may struggle to move higher until investors receive clarity on the pathway for inflation and the Fed.
Investment Themes
- After 2022’s sell-off, fixed income now offers higher yield and more protection against a market correction or economic downturn.
- Solid profit growth and reasonable valuations will be crucial in determining equity winners in a higher rate environment.
- Long-term growth prospects, a falling dollar and wide valuation discounts support international equities.
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Originally Posted July 3, 2023 – Economic Update
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