Global equity prices rallied in January, as inflation continued to recede and investors’ hopes mounted for an end to central bank tightening cycles.

Additional indications that the U.S. and global economies are not falling into recession just yet while inflation continues to recede has led to a nice January rally in global equity prices. With earnings slowing, the market rally appears to be driven by hopes that central bank tightening cycles are near an end and recession can be avoided.

U.S. Economy Grows Despite Mixed Spending Patterns

  • Fourth quarter gross domestic product (GDP) looked solid on the surface at +2.9%. Consumption was +2.1% but softened notably as the quarter progressed. Capital spending was up only 0.7% and barely contributed to growth in the quarter, while housing, a sector of the economy clearly in recession, subtracted 1.3% from growth. Overall, information processing equipment spending was down a whopping 23.4%, but spending on intellectual property, an important element to the reshoring theme, was up 5.3%. Trade and government spending were additional contributors to growth with an outsized contribution coming from inventory investment, which added 1.5% to the quarterly growth number. Some (or most?) of this investment could be involuntary and lead to slower growth in the first half of 2023 if it needs to be worked down.
  • The December personal income and consumer spending report showed the late quarter fade in spending. Personal income rose 0.2% versus the +0.3% estimate, while consumer spending declined 0.2%, worse than the -0.1% estimate with November revised from 0.1% growth to 0.1% contraction.

Improving Inflation Numbers Should Slow Fed Tightening

  • Core personal consumption expenditures (PCE) inflation was +0.3% in December, in line with estimates and a touch higher than the +0.2% reading from November. The closely watched year-over-year core PCE continued its decline, as the higher inflation readings from the end of 2021 roll off. Core PCE landed at +4.4% compared to +4.7% in November. The fourth quarter GDP deflator, which measures changes in the prices of goods and services produced in the United States, showed similar progress at +3.5% compared to +4.4% in the third quarter. These improved numbers to still rather high levels won’t stop the Federal Reserve (Fed) from tightening on Wednesday, but they should confirm that the Fed will tighten at a slower rate. The three-month annualized core inflation rate is now +2.9%, much closer to the Fed’s target and indicative of a positive “real” federal funds rate, which is generally viewed as contractionary monetary policy.

Strong Labor Market Continues to Surprise

  • The U.S. economy continues to experience this double-edged sword of a tight labor market. Weekly jobless claims again surprised to the downside. While there have been quite a few highly publicized layoff announcements throughout January, these have been predominantly white-collar positions, which typically involve severance payments that can delay the filing of claims and mask underlying weakness. Jobs growth for January will be reported on Friday and is expected to be up close to 200,000. The Fed is watching wage growth so any progress in lower average hourly earnings will be welcomed by markets but is not likely to be reflected in the numbers.

Consumers More Optimistic About Inflation Than Business Owners

  • An upside to a tight labor market and strong wage growth is the impact on consumer confidence. The January University of Michigan final sentiment survey confirmed the mid-month flash report, coming in a bit better at 64.9, a nice jump from December’s reading of 59.7. Another encouraging component of the report was the decline in the one-year inflation expectations to 3.9% from 4.4%, a key indication that high inflation expectations are not becoming entrenched in the consumer psyche.
  • Business sentiment is less optimistic than the consumer, as reflected in the January mid-month S&P Global flash manufacturing purchasing managers’ index (PMI) survey, which came in at 46.8, better than the 46.3 estimate and the 46.2 reading from December but still clearly in contraction territory. The services survey also remained in contraction at 46.6, but it beat estimates of 45.3 and was nearly two points higher than December’s 44.7 reading. Both manufacturing and services saw less contraction in new orders but the services sector saw higher wages, which is a particularly sensitive topic around the Fed.

Eurozone Shows Signs of Resilience

  • European equity markets have been as strong or stronger than the United States, as both consumer and business confidence improved in January. Eurozone consumer confidence saw its best reading in a year in a sign of some consumer resilience. Lower inflation and wholesale gas prices were the primary drivers of improving confidence. The eurozone flash composite PMI rose 0.9 points to 50.2, crossing the line into expansion. Milder winter weather, sufficient natural gas inventories, easing supply chains, and the reopening of China were all cited as factors that may help Europe avoid a widely anticipated recession.

Markets Eagerly Await Fed Comments

  • The Federal Open Market Committee meeting this week should produce an increase in the federal funds rate of 25 basis points, but the press conference will be more telling as Chair Jerome Powell will likely continue to warn about the sticky components of inflation, particularly wages.

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