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.
It’s no surprise that inflation has been the biggest headwind for the economy in 2022 and while conditions are likely to marginally improve in 2023, inflation will still be the biggest challenge that markets face. To say we are in unprecedented times seems like a cliché, but the reality is we have not experienced a Fed tightening cycle like this where policy rates have increased by four percentage points in a relatively short period of time. At the same time, the last time the U.S. economy experienced inflation at these levels was over 40 years ago. The biggest cost of inflation is the erosion of real income and lower purchasing power for consumers. Much like flying a plane at cruising altitude to create less air drag, raising rates to an effective level helps mitigate the inflation drag on the economy. The Fed’s decision to accelerate rate hikes and lift rates to a much higher level than the previous cycle was clearly appropriate, but there is also risk when going too fast or too high. Therefore, we are characterizing 2023 as the year of flying at cruising altitude as we approach the Fed’s destination target of 2% inflation. We believe that most of the upward trajectory of policy tightening has been completed, and the Fed appears closer to cruising altitude for policy rates. Incoming economic data appears to suggest that only minor tweaks to policy will likely be needed in the near term.
Furthermore, we expect the Fed to hold policy rates at an elevated level for a longer period as it gains further reassurance that inflation is moving back down. During this flight, the Fed outlook is somewhat uncertain; we definitely expect there will be some turbulence along the way, and we may or may not experience a soft landing, so buckle up, because 2023 could be a wild ride.
Real GDP appears to have settled around pre-COVID level after declines in the first two quarters of 2022. While the two quarterly declines have been attributed to technical imbalances and supply chain blocks, muted 3Q growth is being attributed to a decline from tighter monetary policy. The Federal Reserve’s primary focus is to bring down inflation at any cost. In turn, economic growth and unemployment could suffer as a side effect. While most economists are divided on whether the U.S. encounters a recession in 2023, there is a consensus that any slowdown will likely be shallow. We believe strong corporate balance sheets, flush household savings, and a strong labor market will buffer the economic resilience. Overall, it is our opinion that economic growth will slow and the potential for a recession go up as a result of the Fed’s restrictive monetary policy. Thus, our 2023 outlook for real GDP growth is for -0.50% to 0.50%.
As mentioned earlier, higher for longer appears to be the theme for the Federal Reserve this year as it lifts policy rates to a level is sufficient enough to bring significant improvements to the outright level of inflation. It is important for investors to note that due to the quick acceleration of interest rates, the economy has yet to feel the full effects of the tightening cycle. Additionally, contrary to previous cycles, a pause in rate hikes does not necessarily mean that the Fed is going to immediately cut rates. Looking ahead, the area of most concern for the Fed will be the service sector, where rising wage input costs and the outright lack of labor supply are major headwinds for the Fed to bring down inflation. As such, we think the main risk to our forecast for policy rates next year will be persisting wage pressures. That said, our outlook is for Fed policy to finish 2023 between 4.25% and 4.75% as the potential for a rate cut increases by year‑end.
We are optimistic that inflation has begun a trending path lower with both measures of CPI and PCE showing signs of easing in recent data sets. Most of the decline was around food and energy as the Core PCE (excluding food and energy) remained stable around 5% over the same period. Commodity prices have declined, supply chains have started to normalize, and shelter cost reversion all contributed to the improvement. Consumers have shifted spending habits to service sectors of the economy (hospitality and leisure) and costs in those areas continue to rise, buoyed by rising wages. The Federal Reserve’s goal is to slow the overheated U.S. economy and it will continue tightening interest rates until it believes overall inflation will reach its target. As a result, the U.S. will likely see higher unemployment and slower economic growth next year. We believe that the Federal Reserve’s tighter monetary policy is working, but there clearly is more work to be done. Under that scenario, our outlook for Core PCE (excluding food and energy) improves from its current level but remains elevated at 3.0%-4.0% for 2023.
Performance in 2022 for fixed income will likely go down as one of the worst years ever as aggressive tightening from central banks lifted rates off the zero-bound and even out of negative territory in the Eurozone. However, looking into 2023, the annual trading range for the 10-year Treasury yield will be much narrower with most of the sensitivity coming from the front end of the curve in association with the terminal Fed Policy rate. We envision a much more supported 10-year yield as attractive rate levels and more certainty around Fed policy will entice investors to buy long-end notes. Most notably, we see the balance of risks more neutral as inflation continues to moderate and the Fed gets to a point where it eventually halts rate hikes. Consequently, we can see a scenario where the 10-year moves above the 4% level again, but ultimately our outlook has the 10-year yield finishing the year in a range of 3.50% to 4.00% for 2023.
As expected, price volatility in the S&P 500® Index has remained elevated throughout 2022 and most notably high bond volatility has translated to poor equity returns where this is typically not the norm in lower inflationary environments. We see this consternation continuing as long as inflation is perceived to be an issue that the Federal Reserve must address. However, the S&P 500 Index has remained fairly resilient in the wake of aggressive Fed tightening as margins have been maintained with costs passed down to consumers. The outlook for 2023 will follow a different narrative as input costs are harder to offset and the economic slowdown takes hold. As such, most Wall Street strategists estimate a 0% to 3% growth for 2023 earnings, which is rather benign compared to the 5-year average of 8.6% annually. With the S&P 500 Index currently hovering around 3,950, it is certainly possible that new cycle lows could be made in the first half of 2023 as the Fed battles inflation with additional rate hikes. However, with a shallow recession a likely scenario, the risk of a market swoon appears unlikely. Ultimately, we expect another bumpy ride for investors next year and stocks will continue to be challenged. Our 2023 outlook for the S&P 500 Index is to return -5% to 10%.
Table Columns
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)
Unemployment rate
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
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.
The views, opinions, and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of 12/2022. 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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