2023 is already shaping up to be the year we finally see “the” global downturn. Already we see multiple indicators pointing to sharp declines in economic activity. Indicators that print on a monthly cadence are already showing signs of slumping, such as the U.S. N.Y. manufacturing index and U.S. ISM PMI.
We are also - FINALLY - seeing very firm signs of easing inflation both in the consumer and producer space. U.S. producer price inflation notably declined in December 2022, with moves concentrated in gasoline, energy costs, and food prices. These are the types of moves we didn’t see last year, so it’s good to see the economy is finally responding to the Fed’s moves.
Other indicators linked to international economies also show signs of a global slowdown. We see commodity prices across the board under pressure, although some more than others. Oil prices have dropped considerably from their highs a year ago, whereas natural gas continues to fall with no end in sight. Lumber is literally stuck a mile underwater. Copper and steel prices, however, have increased from their November lows, likely due to increasing China demand as the Party lifts covid restrictions.
The commodity market is unique in its extensive exposure to one of the top drivers of commodity demand - Chinese real estate. However, the Chinese economy is undergoing large structural changes, the consequences of which are hard to predict. China has recently opened itself up after covid, which would obviously be positive for economic demand. But on the flip side, China’s real estate sector is still in serious trouble.
China’s real estate industry output fell 10 percent in 2022, the first decline ever since records were kept in 1999. The decline was most pronounced in commercial real estate, with overall sales volume down 26.7 percent year-on-year (!). Area of new construction also fell an eye-watering 39.4 percent, while real estate financing fell 25.9 percent over the same period.
There are very strong hints that Chinese authorities will be introducing policies to support home buyers and real estate developers, but regardless, experts aren’t expecting any substantial rebound in 2023.
Meanwhile, U.S. Treasury yields remain elevated. Despite the recent inflationary deacceleration, U.S. Treasuries aren’t budging much. The market is likely going to have to see very strong evidence that inflation declines down to 1-2 percent and remains there before the Fed thereby is convinced it can let go of the brakes. One notable move, however, has been the rapid rise in longer-dated yields over shorter-dated yields, a positive sign that suggests recessionary fears may be abating somewhat, as markets reassess the depth of the impending downturn.
The lingering problem in the Fed’s eyes remains elevated employment. U.S. jobless claims are still LOW, meaning the labor market remains tight. The Fed would like to see more people unemployed and looking for work, which would further help curb inflation pressures and thereby justify lower rates. But we just aren’t seeing that.
The likely cause of this is the permanent removal of a portion of the older labor force after covid. A subsection of the baby-boomer generation retired once covid hit, and it’s unlikely we’ll see them come back. This has created a permanent carve-out of labor from the labor pool since baby boomers made up such a large section of the population. Immigration restrictions imposed during the pandemic did not help, either - and haven’t been removed.
In short, the Fed may be hoping in vain for labor markets to return to “normal.” The fact is, it may never will. The employment shift may be structural rather than cyclical.
All in, about 65 percent of economists polled recently think a recession will occur in 2023. Goldman Sachs recently reported they think there is only a 35 percent chance this occurs. And most economists expect the Fed’s FOMC to hike another 50-75 bps this year, which is what markets have already priced in. All else equal, if data is supportive this year, we could actually end up with a net-positive year in markets.
Maybe.
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