Economic Outlook - March 2023
- In response to the rapid rise in interest rates, the U.S. economy has decelerated. After expanding by 3.2% in the third quarter (Q3) of 2022, U.S. Gross Domestic Product (GDP) grew at an annualized rate of 2.7% in the fourth quarter (Q4). However, better than expected data from January showing a strong labor market and improved consumer spending indicate that a contraction is not imminent and growth should continue. New hiring in January was robust, job openings remain plentiful and, despite some layoff announcements, initial jobless claims remain near historic lows. In addition, wage growth has been steady and drove an acceleration in overall consumer spending during the month. Our expectation is for the U.S. economy to grow in 2023, but more slowly, and we forecast U.S. GDP to increase by 1.0%-1.5%.
- Inflation as measured by the personal-consumption expenditures (PCE) index has been reduced significantly since the fall of 2021. However, this progress has come primarily through reductions in prices in the volatile goods categories such as food and energy. The “core” PCE, which excludes food and energy, has also seen reductions, but recent data show price increases continuing at elevated levels. Core PCE was up 4.7% in January which was unchanged from December. Furthermore, the Federal Reserve has shifted its focus to services inflation, including wages. The services component of the Consumer Price Index (CPI) grew at an annual rate of 7.6% through January. Finally, owing to tight conditions in the labor market, wage growth appears stuck at around 5%. The Federal Reserve has repeatedly emphasized that their objective is for inflation to return to 2%.
- Federal Reserve officials acknowledge that there’s more work to do in bringing inflation down. The implication is that monetary policy could require further tightening than currently expected. The next meeting of the Federal Open Market Committee (FOMC) is March 21-22 and an increase of 0.25% in the target rate for federal funds is expected. This would bring the target range for the federal funds rate to 4.75%-5.0%. In their Summary of Economic Projections released last December, FOMC officials provided a median projection of 5.1% for the peak (“terminal”) rate for federal funds. In subsequent commentary, those officials have left open the possibility for the terminal rate projection to move higher in order to get inflation under control. The next Summary of Economic Projections is due at the March meeting.
- The fixed income markets have taken note of the better than expected economic data and stalling out of progress on inflation and yields on U.S. Treasury obligations have been rising. The 2-year Treasury is the most sensitive to changes in short term rates by the Fed and its yield has surpassed its recent high seen in November of 2021. Other maturities along the spectrum are following suit and the 10-year Treasury yield is nearing 4%. According to Bianco Research, in past monetary tightening cycles, the yield on the 2-year Treasury has exceeded the eventual terminal rate for federal funds.
Source: Bloomberg, FactSet, U.S. Government, Dow Jones, Conference Board, Federal Reserve
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