Growth
Real GDP grew by a 1.1% annualized rate in 1Q23, a sharp deceleration compared to last quarter’s 2.6% pace. Consumption and government spending looked strong, growing at annualized rates of 3.7% and 4.7%, respectively. However, most of the consumption gains can be attributed to a strong January. These gains were partially offset by declines in private inventories and residential fixed investment. In particular, equipment spending fell sharply, indicating 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 April Jobs report highlighted continued resilience in the labor market despite several indicators suggesting a slowdown. Nonfarm payrolls rose by 253K, beating expectations of 185K, while the unemployment rate fell back to its historic low of 3.4%. Wage growth accelerated as average hourly earnings grew 0.5% m/m and 4.4% y/y. This report may reduce the odds of imminent Fed rate cuts, but the labor market is also a lagging indicator of the economy and can change rapidly once conditions deteriorate. We still expect broader signals of a softening labor market, such as declining job openings, to flow through to aggregate labor data in the months ahead.
Profits
The end of the 1Q23 earnings season is approaching, and results continue to look better than expected. With 462 companies having reported (90.8% of market cap), our current estimate for 1Q23 operating earnings per share is $53.42. If realized, this would represent y/y growth of 8.2% and q/q growth of 6.1%. So far, 69% of companies have beaten earnings expectations, while 66% have beaten revenue expectations. Importantly, profit margins bounced in 1Q23, with our current estimate tracking 12%.
Inflation
Inflation temporarily bounced in April, with headline and core CPI both rising by 0.4%, bringing y/y gains to 4.9% and 5.5%, respectively. Shelter remained the largest contributor, although owners’ equivalent rent increased at a softer pace, while used vehicle and gasoline prices also contributed. However, the Manheim Used Vehicle Index fell in April, suggesting that the upwards pressure from used cars will be temporary. Overall, this report should not change the Fed’s plan to pause tightening. The disinflationary trend remains well established, as April marked the 10th consecutive month of slower y/y inflation, and y/y headline CPI could fall to 3.5% by June.
Rates
At its May meeting, the FOMC voted unanimously to hike rates by 0.25% to a range of 5.00%-5.25%, the highest level since June 2006. Since the first meeting of the year, statement language on policy has shifted from “ongoing increases will be appropriate” to a more data-dependent approach, hinting that the Committee is ready to pause rate increases but maintains the willingness to hike further if economic conditions warranted. Powell continued to push back against the idea of rate cuts later this year as the Committee expects inflation will fall more slowly than what markets anticipate.
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 remain depressed and volatile until investors receive clarity on the pathway for inflation, the Fed and the debt ceiling.
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 May 15, 2023 – Economic Update
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