Growth
The economy grew at a 2.4% annualized rate in 2Q23, a modest acceleration from last quarter’s 2.0% pace. Consumption grew at a modest 1.6%, better than expected, while private domestic final sales increased at a 2.3% rate, the fastest since 4Q21. Business fixed investment spending also grew 7.7%, its best pace since 1Q22. The GDP price index also showed further progress, with core PCE increasing at a 3.8% annual rate from 5.3% last quarter. The economy is clearly showing resiliency in the face of monetary tightening , but strains on the consumer and business spending may temper growth in the following quarters.
Jobs
The August Jobs report provided further evidence that the labor market is softening. Nonfarm payrolls rose by a stronger than expected 187K. However, revisions cut 110K jobs for the last two months, suggesting a slowdown in hiring. A large increase in the labor force pushed the unemployment rate higher to 3.8%, while wage growth came in below expectations, gaining 0.2% m/m and 4.3% y/y. Overall, this report still shows decent momentum in the labor market and a recession this year seems unlikely. That said, a more balanced labor market and easing wage pressures should allow core inflation to move lower, reducing the need for the Fed to hike further.
Profits
Earnings remained resilient during the 2Q earnings season. Our final estimate for 2Q 2023 operating earnings per share is $54.90, representing y/y growth of 17.1% and q/q growth of 4.5%. While a strong 71% of companies beat earnings estimates, only 53% beat revenue expectations amidst slowing inflation. Importantly, profit margins improved, with our current estimate tracking 11.9%. Financials was the largest contributor to EPS growth, while the energy sector was the largest detractor.
Inflation
The August CPI report showed continued progress on core inflation while headline inflation moved higher. Headline CPI rose 0.6% m/m seasonally adjusted and 3.7% y/y non-seasonally adjusted, an acceleration compared to last month. Importantly, this largely anticipated jump was driven by a 5.6% surge in energy prices, as consumer prices rose a more modest 0.3% excluding energy. Core CPI rose 0.3% m/m and eased to 4.3% on a y/y basis. In the details, shelter inflation continued to moderate while transportation services saw strong gains. However, moderating new and used vehicle prices in the months ahead should ease inflationary pressures from this category. Moving forward, we expect that the impact of oil price spikes will be limited, and this report bolsters the case for the Fed to pause rate hikes.
Rates
In a widely anticipated move, the FOMC voted to leave the federal funds rate unchanged at a range of 5.25% to 5.50% at its September meeting. The updated “dot plot” remained hawkish, with the median FOMC member now expecting only two cuts in 2024. This likely stems from the Fed’s expectation for continued economic resilience. In the Summary of Economic Projections, real GDP growth expectations rose meaningfully for 2023 and 2024. Elsewhere, the median forecast for the unemployment rate fell to 3.8% while the core PCE forecast ticked lower. Overall, the Fed appears to be forecasting a “soft-landing” scenario. However, with plenty of headwinds facing the current economic expansion, the risk of overtightening could challenge this outlook.
Risks
- Tighter lending standards, weakness in commercial real estate and an overly aggressive Fed could threaten economic growth.
- Elevated equity valuations leave the market susceptible to corrections.
- Markets may struggle to move higher until investors receive clarity on the potential for a recession.
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 September 25, 2023 – Economic Update
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