February 2023 | Equity Commentary
Published on March, 16th, 2023
The ‘economic good news is bad news’ trade was on in February, with the S&P 500 falling 2.5% for the month. The 10-year US Treasury bond yield rose from 3.5% to 3.9%, essentially reversing January’s move.1 During the month, we believe inflation readings appeared hotter than financial markets may have expected, and the economy showed few signs of weakening substantially. This occurred in the backdrop of the Fed having slowed the pace of rate hikes from four consecutive 75bp hikes in June, July, September, and November, to 50bps in December and 25bps in early February.2 In testimony before the Senate Banking Committee on March 7, Chairman Jerome Powell said “if the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” noting that recent data appeared to mark a reversal in the prior trend of cooling inflation. Interest rates futures markets continue to bid up expectations for the benchmark fed funds rate in 2023. At the last Fed meeting, market expectations were for peak fed funds of 4.9% in May, falling thereafter to a year-end level of 4.3%. By March 6, investors were forecasting a peak rate of 5.5% in September, declining only modestly by year end to 5.4%.3
Inflation data released in February did not offer much encouragement to the Federal Reserve, in our opinion. The Fed’s preferred measure of inflation – the Personal Consumption Expenditures (PCE) price index – increased by 5.4% year-over-year in January, which was slightly worse than December’s 5.3% print.4 The Consumer Price Index (CPI) and the Producer Price Index (PPI) continued to show improvements year-over-year, but the pace of deceleration slowed – a point we believe is not lost on market watchers and the Fed.
The Labor Department reported a 6.4% year-over-year CPI increase in January, which marked only a very modest improvement from December’s 6.5% rate of increase. More worrisome to us was the month-over-month change in CPI, which at 0.5% from December to January was a significant move higher than the previous month’s 0.1% increase. Core prices, which exclude energy and food, were up 5.6% year-over-year, again only a slight improvement from December’s 5.7% year-over-year increase.5 Much like January’s CPI report, the January’s PPI improved year-over-year compared to December, but the 0.7% month-over-month from December to January was a sharp reversal from December’s -0.2% decline from November.6
We believe the divergence between goods and services continues to be the key sticking point in today’s inflation story. Core goods prices have stabilized while shelter costs (a key component of services) rose at their fastest annual pace since 1982.7This inflationary pressure is a byproduct of continued strength in the labor market, coupled with consumers increasingly shifting their spending from goods to services. Consumers spent more in restaurants, bars, and hospitality in January, helping drive a 3% increase in retail sales from December to January – the biggest monthly jump in almost two years.8
Energy’s contribution to inflationary pressures also remains high on our watchlist, particularly as the war in Ukraine continues. In response to Western oil sanctions, Russia announced it would cut oil production by 5% in March.9 In our view, this move should not impact global oil prices very much, but it does appear to signal Russia’s willingness to potentially disrupt global energy markets.
Regarding the outlook for services inflation, the US labor market continues to look largely unresponsive to Fed rate hikes, in our opinion. Nonfarm unemployment jumped by 517,000 in January, which blew past consensus expectations for a roughly 200,000 increase10. Initial jobless claims – a proxy for layoffs – were also seen ticking slightly lower in the last week of February, which suggests to us, that employers continue to desperately cling to workers. First-time applications for unemployment benefits fell to 183,000, the lowest reported level since April 2022, and unemployment rate fell to 3.4%, a 53-year low.11 One bright spot for the inflation picture is that average hourly earnings rose 4.4% year-over-year in January, which marked the smallest increase since August 2021.12
Economic data in services and manufacturing remains mixed, in our view. In February, S&P Global’s index of services businesses rose to 52.1 pushing it back into expansion territory and marking the strongest reading in eight months. U.S. companies that participate in the surveys reported their first growth in output since last summer and indicated optimism about activity in the months ahead.13
S&P Global’s February manufacturing index reading rose to 47.3 from 46. in January. While still contractionary, the improvement suggests that activity is contracting at a slower pace, and manufacturers indicated that softer demand has allowed them to work through the backlogs that remain a legacy of the pandemic ISM’s survey also showed contraction.14 Businesses said they were slowing output in anticipation of weak demand in the first half of 2023, but that expectations were in place for a growth pickup in the second half. A key data point, in our view, from the survey was that the index for input prices moved above 50 for the first time since September, a cautionary sign that price pressures could be creeping higher again.15
Sources
1Bloomberg. SPX 500 Index DES. USGG10YR GP Function
2United States Fed Funds Rate – 2023 Data – 1791-2022 Historical – 2024 Forecast
3Bloomberg: Implied Overnight Rate & Number of Hikes/Cuts 12/14/22 and 3/6/23
4Personal Income and Outlays, January 2023 _ U.S. Bureau of Economic Analysis (BEA).pdf
6Producer Price Index News Release summary – 2023 M01 Results.pdf
8U.S. retail sales roar back; manufacturing shows improvement _ Reuters.pdf
9Russia to cut oil output by 500,000 bpd in March _ Reuters.pdf
10https://www.cnbc.com/2023/02/03/jobs-report-january-2023-.html
11https://www.wsj.com/articles/january-jobs-report-unemployment-rate-economy-growth-2023-11675374490
13Global economic growth accelerates to eight-month high in February _ S&P Global.pdf
14https://www.pmi.spglobal.com/Public/Home/PressRelease/f982d001dbbe4b4daec4f54d2260874e
15February 2023 Manufacturing ISM® Report On Business®.pdf
As of March 16, 2023
