Higher interest rates plus higher commodity prices (energy + metals + food) indicate that we are likely headed for a period of below-trend economic growth. Central banks seem intent on moving to a more neutral policy setting (against the backdrop of continued global supply shocks).
The ECB may delay rate hikes, but is looking to accelerate the end of asset purchases.
In the U.S., the CPI surged +0.8% month over month and 7.9% year over year in February. The core (ex food & energy) CPI rose +0.5% month over month and 6.4% year over year in Feb. Upward pressure is set to continue in the price data in March.
The Atlanta Fed’s tracking estimate for Q1 real GDP in the U.S. is at 0.5% quarter over quarter annualized rate., i.e., barely positive. NFIB’s measure of U.S. small business optimism declined month over month to a weaker than expected 95.7 in February. The U of Michigan consumer sentiment measure fell to a new cycle low in early March.
We continue to watch for additional shocks. We’ve already overwhelmed the global supply chain, as bottlenecks developed & core goods inflation (which usually doesn’t move much) skyrocketed in 2021. Inflation is now threatening to influence future expectations & become stickier (eg, U.S. rents moving higher).
Russia/Ukraine get most of the global headlines, for good reason. The situation here obviously continues to be fluid.
But we are also paying attention to the health situation in China. “China has shut down an industrial city, urged residents not to leave Beijing and closed down schools in Shanghai due to an increase in cases … Chinese officials reported 588 new confirmed cases in the 24 hours ending on Friday, but no deaths. That included 134 confirmed cases in the northeastern Jilin province, a number which prompted a shutdown of Changchun, a city with 9 million residents, The Associated Press reported. On Saturday, the mayor of Jilin was replaced, as was the mayor of Changchun.” (The Hill)
The message of the U.S. yield curve (flatter but not inverted) still seems to be that a soft landing is possible. But this is getting more tenuous, and it’s going to have to be a joint effort (Fed + private sector). The Fed cannot bring inflation down by itself without tightening substantially.
Bottom line: With supply & demand not yet balanced, we are seeing additional shocks. Health & geopolitical uncertainty might typically give central banks pause. But having waited to begin their tightening cycles, numerous central banks will likely have to forge ahead with higher rates (despite the global uncertainty).
The U.S. economy remains in a “full-employment” position (eg, initial jobless claims at 227,000 last week). Wage data (especially the U.S. Employment Cost Index & Atlanta Fed wage tracker) also remain key for our outlook. The Fed will tighten to stop inflation from becoming entrenched broadly in future expectations. We still expect March, May, and June Fed hikes (+25 bps each) to start the cycle, before settling into a 1 hike-per-quarter pattern into 2023. Quantitative Tightening (QT) should follow several meetings after liftoff. In this environment, it remains tough for bonds to hedge stocks like they did during the past several decades.
As we’ve noted previously, our base case is a 2023 mid-cycle slowdown (50% odds) as the private sector helps the Fed bring inflation under control (eg, bottlenecks ease). With the domestic labor market still solid, and JOLTS job openings elevated, it remains difficult to make a U.S. recession our base case. Yet if the Fed overdoes tightening, growth would falter (35% odds). An upside surprise case would involve productivity increasing and growth proving robust (15% odds).
Source: Strategas
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments. Data provided by Refinitiv.
Sincerely,
Fortem Financial
(760) 206-8500
team@fortemfin.com
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