Representatives from Allianz Investment Management LLC provide commentary on market and economic indicators, including Federal Reserve actions, interest rates, credit markets, and economic releases such as inflation, GDP, consumer confidence, housing, retail sales, and job unemployment news. Here is their updated insight on the economic and market outlook for the rest of 2022.
Allianz Investment Management LLC 3Q Market Update
- Despite outsized front-loaded rate hikes from the Fed, the overall economy has yet to signal a strong reaction and the Fed has tripled down policy tightening in the near term.
- Robust labor market conditions continue buoy the economy and have not helped the Fed’s case in their quest to bring down historically high inflation levels.
- Markets and the Fed alike are now projecting the Fed fund’s rate to be north of 4% by year end as the Fed brings interest rates up to levels we have not seen since the Great Financial Crisis.
- Higher rates will eventually take a toll on the economy, and we are already witnessing some of the aftermath within the housing market, but yield curves have yet to signal an outright recession as the 3-month yield, relative to the 10-year yield, has not inverted.
- Equity markets have certainly been volatile as the Fed unwinds easy monetary policies, and the outlook isn’t looking any brighter on the horizon with the level of hawkishness picking up.
Market update: The third time’s the charm
Perhaps the third time is the charm for a Fed that has been forced to recalibrate monetary policy yet again in the wake of stubbornly high inflation levels. With the economy still riding the tailwinds of over-stimulated policies, the Fed has run into a problematic situation in which interest rates have to be lifted significantly in a short period of time to create enough restrictive friction on consumer demand. Despite the swift rise in policy rates, the economy has been able to carry on. The labor market continues to look solid as job openings remain high, employment separations are quite low, and the unemployment rate has stayed below 4%. On the other hand, inflation has become more entrenched into the economy as factors that enable so-called “sticky inflation” have been more prevalent in recent months. Particularly on the wage front, the upward pressure on employment costs has been a major headwind for the Fed in the attempt to bring down inflation. Therefore, against a backdrop of rising rates and a Fed steering the economy towards a recession, it makes sense for investors to take a more cautious approach in their portfolios as more turbulent markets are likely the norm for the foreseeable future.
2022 U.S. economic and market outlook
U.S. GDP 1.75% – 2.75%
Real GDP has shown declines the first two quarters of 2022. Many economists blame the weakness on a widening of the trade balance and supply chain constraints. Investors see two consecutive declines and think that we are in, or at least on the cusp of, a recession. However, unemployment remains at historic low levels not seen since December 1969, and the U.S. consumer continues to spend rather than retrench; both contradict what we would see in a recessionary period. While we agree that economic growth is likely slowing due to the Federal Reserve’s monetary policy tightening, personal consumption, the largest component of GDP, remains very strong and will support economic growth through year-end. Currently, we do not see a recession occurring in 2022, and we expect positive economic growth for the remainder of the year. We are unchanged with our year-end GDP growth estimate within a range of 1.75% - 2.75%.
Fed funds rate 4% – 5%
Looking back to the beginning of the year, I don’t think anyone could have imagined the Fed being this aggressive with policy rates. The goal posts have been shifted three times as the Fed has embarked on an all-out-war against inflation. The recent rate hike in September marked the third consecutive 75-basis-point rate hike as the Fed continues to front-load rate hikes during this cycle. The swift tightening from the Fed has caused some challenges in relation to the shape of the yield curve as short-term rates have moved up much faster than long-term rates, which has led to a flatter yield curve environment. When it comes to the idea of peak hawkishness from the Fed, we think there is still some room to go. Market participants are now projecting Fed funds to rise above 4%, and the risk leans in the direction of a 5% Fed funds rate should inflation continue to stay well above the Fed’s goal of 2%. As a result, we expect more volatility in risk assets such as equity markets, and investors should prepare for choppy markets ahead.
Inflation 4% – 5%
While some are debating that inflation has reached a plateau, it is turning out to be a very stubborn opponent. For example, the price of gasoline, along with some other commodities, has declined over the summer, but others endure at elevated levels. The imbalance of natural gas around the world due to the Ukraine-Russia war has caused the price to more than double. This could negatively impact the amount of discretionary income U.S. consumers have to spend on other goods and services as we move into the fall and winter months. Americans continue to feel the inflationary prices in areas like rent, groceries, and medical care, which were cited by the Bureau of Labor Statistics as large contributors to their Consumer Price Index. The Bureau reported that their measure of inflation was +8.3% year over year in August. To combat these high prices, the Federal Reserve has increased their Federal Funds rate by 3.00% this year, including 0.75% at each of its last three meetings. Their goal is to slow the overheated U.S. economy to a more sustainable inflation rate of 2.0%. As a result, the U.S. will likely see higher unemployment, slower economic growth, and higher interest on business and personal loans than we have seen recently. We feel that the Federal Reserve’s tighter monetary policy will eventually take hold, but inflation will be more persistent in the near and medium term. Under that scenario, we are keeping our inflation forecast on Core PCE at 4.0% - 5.00% for 2022.
10-year treasury 3.75%
Yields have risen significantly this year and while we have seen the shape of the curve flatten, the 10-year yield is up over 220 basis points year to date. Part of this is a reflection of the normalization of policy that is occurring from the Fed with policy rates going up and quantitative easing coming to an end. However, the reality is there is a normalization of interest rates that is occurring across the globe as central banks raise rates and negative interest rates become a policy experiment of the past. As a benchmark signal, the 10-year yield doesn’t currently point to a recession on the horizon as the spread between the 3-month yield and the 10-year yield has not inverted yet. Although, we do agree the risk of a recession has been on the rise. Overall, we believe current 10-year levels look fairly valued, and we are not expecting a significant increase from the top end of our forecasted range at 3.75%.
U.S. equities -20.00% – -10.00%
Equity markets have continued to be volatile in response to the Federal Reserve action to tighten monetary policy. While uncertainty surrounds the amount of restrictive action needed to control inflation, we expect their efforts to slow economic growth. Analysts at the major banks have finally started to accept this premise and have begun to reduce their S&P earnings estimates for U.S. equities. Companies such as Salesforce and FedEx have recently moved toward more tenuous outlooks for their future profits. Additionally, the Fed’s tighter monetary policy has compressed the S&P 500 Forward Price-to-Earnings (P/E) multiple, adding downward pressure to equity prices. According to FactSet®, the 12-month forward P/E multiple has been hovering around 16x during 3Q, well below the 5-year average of 18.6x. The Energy sector has been the bright spot in the equity space, despite the recent decline in the price of oil. Value style stocks continue to outperform as the P/E multiple compression on equities has affected growth style names more heavily. We expect U.S. equities to remain challenged in the near term with earnings and economic uncertainty at the forefront. It is for these reasons that we maintain our expectation on the S&P 500® Index return for 2022 of -20% to -10%.
List of definitions
Here are the definitions of the key terms used in this market report.
Previous – Observation as of the end of the prior month
Survey – Economist survey prediction for current month’s observation
Actual – Actual observation as of the end of the current month
Next – Date of next period’s observation
ISM Manufacturing Index
Based on a survey from the Institute for Supply Management, this index indicates a positive growth in the manufacturing sector when the figure is above 50 and a contraction of the sector when it is below 50. An increase in the figure indicates either slowing contraction or accelerating growth. The index represents underlying figures in employment, inventories, new orders, production levels, and deliveries. (Source: Bloomberg)
Based on a monthly survey of households, the unemployment rate is one of many figures in the Current Population Survey that move markets by indicating what portion of the population is at work, looking for work, what they are getting paid, and how many hours they work. The unemployment rate is the percentage of workers unable to find work who are actively seeking a job. The survey is conducted by the Bureau of Labor Statistics.
Retail sales measure the total amount of purchases by consumers in stores that sell merchandise, food, and other services to end consumers. This measure is a significant indicator of trends in consumer spending, which moves markets because consumer spending accounts for over two-thirds of U.S. economic output. Data is compiled by the U.S. Bureau of the Census.
Consumer Price Index (CPI)
The Consumer Price Index measures the prices of a fixed basket of goods that reflect an average consumer’s cost of living. CPI is a popular indicator of inflation, driving prices on U.S. inflation-linked bonds, and is used to adjust tax brackets and Social Security payments. CPI is compiled by the Bureau of Labor Statistics monthly.
Home Price Index
The S&P CoreLogic Home Price Index is the seasonally adjusted average price of residential homes in 20 major cities in the U.S. Data is published with a two-month lag (numbers available in March reflect price changes from January). Housing prices affect consumer wealth and consumers’ ability to borrow and spend, which in turn affects U.S. economic growth.
Gross Domestic Product (GDP)
Gross Domestic Product is the sum of the value of all goods and services produced in the economy. It is one of the most comprehensive benchmarks for economic performance. Real GDP measures economic productivity adjusted for inflation, which measures growth that is not due to goods getting more expensive. GDP is published by the Bureau of Economic Analysis.
University of Michigan Consumer Sentiment Index
The index is derived from surveys of 500 households by the University of Michigan on consumer finances and attitudes regarding the economy. The index is set to 100 as of 1966, reached a high of 107.3 in June of 1999 and a low of 56.4 in June of 2008. High consumer confidence levels lead to robust consumer spending, whereas low consumer confidence levels lead consumers to pull back on spending.
S&P 500® Index
The S&P 500® Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.
Chicago Board Options Exchange (CBOE)
Volatility Index® (VIX® Index)
Created by the Chicago Board Options Exchange (CBOE), the Volatility Index®, or VIX®, is a real-time market index that represents the market’s expectations of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500® index options, it provides a measure of market risk and investors’ sentiments.
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The views, opinions, and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of 10/2022. This document is provided for informational purposes by AIM LLC, a registered investment adviser that is a wholly owned subsidiary of Allianz Life Insurance Company of North America. These views may change as interest rates, market conditions, tax rulings, and other investment factors are subject to rapid change which may materially impact analysis that is included in this document. This report does not constitute a solicitation or an offer to buy or to sell any security, product, or service. It is not intended and should not be used to provide financial advice as it does not address or account for an individual's circumstances. Consult with your advisor and tax professional before taking any action based upon the information contained in this document. Past performance does not guarantee future results and no forecast should be considered a guarantee. Any investment and economic outlook information contained in this document has been compiled by AIM LLC from various sources, including affiliated entities. AIM LLC takes reasonable steps to provide up-to-date, accurate, and reliable information, and believes the information to be so when provided, but no representation or warranty, express or implied, is made by AIM LLC as to its accuracy, completeness, or correctness.
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