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Allianz Investment Management LLC 2023 3Q Market Outlook

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 2023 3Q Market Outlook.

business team talking

Key points:

  • Economic resilience in the U.S. has paved the way for higher interest rates in the long-end of the curve.
  • Growth and consumption were particularly strong during the summer months, which added to overall GDP growth.
  • Further evidence of inflation slowing has been welcomed by the Fed, but we are still a long ways away from their 2% target.
  • The Fed has lifted policy rates to a range of 5.25% to 5.50%, and we think the end of the hiking cycle is close if not happened already.
  • Labor conditions in the U.S. still remain strong with the unemployment rate at 3.8%, but lower job openings and slowing wage pressures signal some moderation.
  • Inflation is expected to remain above the Fed’s 2% goal and the reaction function of the economy to current monetary conditions continues to lag.
  • The higher for longer theme appears to be fully priced into the bond market, but near term headwinds could make rates susceptible to a quick reversion.
  • Equity markets have largely been unfazed by the higher interest rate environment, but the recent steepening of the yield curve has started to put some pressure on risk assets.

Q4 Outlook – Is the soft landing possible?

Inflation is declining as the Federal Reserve tightening policy has taken firm hold. The question remains whether their actions will produce the lower inflation environment they expect without pushing the U.S. economy into a recession. The consensus currently points in favor of the Fed’s ability to avoid a recession; however, soft landings are rare from a historical perspective. Federal Reserve interest rate hikes take time to work through the economy. Long variable lag times of over a year are generally associated with interest rate hikes before the full impact is felt. Twelve months ago, the Fed had only increased rates 3% of the 5.25% felt thus far, so there is still plenty of restraint to be felt in the pipeline. We believe that a slowdown is still probable; however we now see it as a 2024 event. This leads us to be cautiously optimistic on economic growth through year end 2023.

Consumer spending has been resilient and unemployment has remained steady, allowing economic growth to remain positive as inflation declines. Waning consumer savings and the policy to restart student loan payments could be headwinds going forward. We think there is an equal probability of one more rate hike from the Fed in this tightening cycle before they go into a holding pattern. How long this pattern persists will depend on how the economy reacts, so we expect to hear the phrase “data dependent” for the foreseeable future.

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U.S. GDP Growth

U.S. Gross Domestic Product came in at +2.1% annualized for 2Q23, up from the1Q23 final print of 2.0%. Consumer spending continues to be one of the largest contributors to economic growth. The unemployment rate continues to be resilient, which is also supportive of the economy. The consensus probability of an economic downturn that was highly anticipated at the beginning of this year is decreasing or at least is seen being pushed into 2024. These reasons are all positive for economic growth to continue. In fact, the 2.1% economic growth rate in 2Q23 matches the average growth rate from 1999-2019, so it has returned to pre-COVID “normal.” We also believe that the pending slowdown has likely been pushed into 2024. This allows us to raise our outlook on Real GDP to +1.75% to +2.25% for 2023.


Fed funds rate

While the September FOMC meeting was widely viewed as a “skip” meeting, we think it still remains to be seen if another hike is in the cards later this year. Fed officials appear to be somewhat divided on whether higher policy rates are needed to bring inflation back down to their 2% target as seven of the nineteen Fed officials did not have another hike in the dot plot. In addition, there are significant risks to economic activity on the horizon with the autoworkers strike in motion and the potential for a government shutdown looming. Both these events have the potential to sideline the Fed from another hike this year, especially given that a government shutdown would effectively delay the economic data that the Fed relies on to make policy decisions. Thus, we believe there is a decent case building that the last rate hike during this cycle may already be behind us. However, looking beyond the terminal rate, the Fed’s projections did show fewer rate cuts in 2024. The idea of keeping short-term interest rates higher for longer gives the Fed more optionality should the economy fail to materially slow. When we think about rate cuts coming from the Fed next year, it will be important to track where real rates are, and real rates above 2% is considered relatively restrictive on a historical basis. For the balance of the year, we are forecasting Fed funds to end within a range of 5.25% and 5.75% should the Fed to decide to hike once more.

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Inflation has declined over the past year according to both the Personal Consumption Expenditures (PCE) measure and the Consumer Price Index (CPI). The Federal Reserve monetary policy rate hikes have started to bite, stabilizing prices across many areas of the U.S. economy. One example of this is used vehicle prices, which have retreated -6.6% over the last 12 months according to the August CPI report. Rent prices remain sticky, however, preventing both inflation measures from feeling the full effect of the Fed’s tightening policy. Shelter was +7.7% year over year (yoy) in the July 2023 CPI data, but real time data by CoreLogic showed +3.4% over the same period. The Fed’s preferred inflation measure, Personal Consumption Expenditures, posted +3.3% year-over-year for July 2023, down from +4.2% just five months earlier. Core PCE (ex Food and Energy) posted +4.2% for July 2023, down from +4.7% in January. We anticipate that PCE inflation will continue to improve as the economy slows further. Given this environment, we maintain our range of +3.0% to +4.0% for core PCE to end the year.

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10-year Treasury

A perfect storm for U.S. rates markets has shifted the yield curve yet again to levels we have not seen since before the Great Financial Crisis. The combination of the Fitch downgrade to U.S. government debt, a surge of new issuance after the debt ceiling was lifted, and resilient consumer spending throughout the summer months has pushed the 10-year Treasury yield to year-to-date highs north of 4.30%. The question many investors are asking is when will the eventual economic slowdown finally take hold. Despite falling inflation, 10-year yields have diverged and gone the opposite direction. However, we do believe the Fed is on the cusp of being done raising rates for this cycle and history has shown the 10-year Treasury yield has declined by more than 50 basis points in first three months after the last rate hike. We take note that the swift move higher in the 10-year yield following the September Fed meeting has pushed yield levels above fair-value models Thus, with the potential of a government shutdown emerging, we believe 10-year yields could be susceptible to a rapid shift lower. During the last government shutdown, in the weeks leading up to the December 2018 shutdown, 10-year rates declined by over 50 basis points from peak to trough. As a result, we are forecasting the 10-year yield to finish the year between 3.75% and 4.25%.


U.S. Equities

S&P 500 earnings came in positive for 2Q23, following a better than expected 1Q23. We are watching company net profit margins as an early sign of economic slowdown; however those seem stable for now. S&P 500 net profit margin recorded 11.6% for 2Q23, unchanged from 1Q23, which compares favorably to the 5-year average of 11.4% according to FactSet®. Wall Street strategists have taken notice with firms like Goldman Sachs, Citi, and Oppenheimer increasing their year-end targets for the S&P 500. Large-cap growth continues to outpace value year to date according to S&P, with Information Technology and Communication Services sectors leading the way and Utilities lagging. Equity valuations seem stretched but investor sentiment has grown more positive as the thought of recession has declined. We still believe the mild slowdown will occur; however the longer it is delayed the better it will be for U.S. equities in 2023. This outlook, along with a positive earnings surprise and stable net profit margins, allows us to increase our target return on the S&P 500® Index to +10 to 20% for 2023.


List of definitions

Here are the definitions of the key terms used in this market report.

The views, opinions, and estimates expressed above reflect the views of Allianz Investment Management LLC (AIM LLC) as of September 2023. 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.

Products are issued by Allianz Life Insurance Company of North America. Registered index-linked annuities (RILAs) are distributed by its affiliate, Allianz Life Financial Services, LLC, member FINRA, 5701 Golden Hills Drive, Minneapolis, MN 55416-1297. 800.542.5427 www.allianzlife.com