hero july market commentary

Allianz Investment Management LLC 2023 Mid‑Year 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 mid-year outlook.

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Key points:

  • Labor market demand has slowed, but recent data for the month of May is sending some mixed signals with wage growth slowing and payrolls expanding.
  • Inflation overall is moving lower, but at the core services inflation remains stubbornly sticky.
  • The trajectory of the economy appears to be slowing as the effects of monetary policy are finally starting to bite.
  • Even with debt ceiling debate aside and banking sector fears subsiding, the Fed has taken a pause in the rate hiking campaign.
  • 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.
  • We expect a higher for longer theme to remain for interest rates as policy stays restrictive and rate cuts are pushed out until next year.

Mid-Year Outlook – Higher for Longer

As ominous signs of a recession continue to build, some Fed officials, as well as other market participants, are becoming more impatient while they wait for an inevitable downturn of economic activity. Investors should keep in mind that it can take a considerable amount of time for monetary policy effects to take hold and really bite into the consumer. Monetary policy has tightened sharply in a very short period of time relative to the last hiking cycle. Another primary factor that is buoyantly propping up the U.S. economy is the reluctance of some companies to lay off employees, recalling the lessons of rehiring after the pandemic. Either way, the overall tightness in the labor market has led to a prolonged spending pattern for the consumer and kept the economy from abrubtly slowing. From a monetary policy perspective, a delayed economic slowdown is causing the market to re-think the path of policy rates. The main idea being that the Fed will have to hold rates at an elevated level for a longer period ot time to ensure the economy effectively slows and inflation continues to move toward the 2% target. Depending on the path of the economy, a rate cut might not be in the cards until early 2024. That being said, we are still expecting a decline of economic activity in the second half of this year as discretionary spending weakens and the labor market deteriorates further, but it’s simply taking more time for the narrative to unfold.

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U.S. GDP Growth

U.S. Gross Domestic Product came in at +1.3% annualized for 1Q23, down for the third consecutive quarter as government and consumer spending were the largest positive contributors. While the unemployment rate continues to be resilient as we proceed deeper into 2023, the number of job openings and the number of employee “quits” are declining as more companies and American workers prepare for a possible economic slowdown. Additionally, the number of indicators such as ISM Manufacturing Index, U.S. Leading Indicators, and the NFIB Small Business Optimism Index are adding to the signs of a pending downturn. Given this backdrop and our expectation for a mild economic contraction in 2H23, we are maintaining our outlook for Real GDP to finish -0.5% to +0.5% for 2023.


Fed funds rate

The Fed refrained from raising the policy rate at the June meeting, and this was the first meeting during this tightening cycle that the Fed has not raised rates. The explanation from Chairman Powell gave mixed signals, but the reality is the Fed is looking for time to evaluate how the economy will evolve from here with a Fed Funds rate north of 5.0%. The most recent meeting also gave some insight to where policymakers see rates at the end of the year, and while the committee is mostly divided on this topic, on average they see one or two more rate hikes by year end. We think the most plausible argument for a pause in rate hikes is the uncertainty around lagging effects to the economy, given the banking stress in March. Our base view is that most of the policy tightening is likely done and one or two more rate hikes from here is not likely to change the trajectory of the economy. With recent inflation data remaining somewhat sticky, we can see why rate cuts are being pushed out into 2024, but the closer we get to a real economic slowdown the higher the bar gets to continue raising rates. Therefore we believe the Fed is more likely to maintain a higher for longer policy stance rather than continuously raising rates, and we maintain our target for Fed funds to end in a range of 4.75% to 5.25% for the end of 2023.

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Headline inflation has declined noticeably since year end according to both Personal Consumption Expenditures (PCE) and Consumer Price Index (CPI). Tighter financial conditions created by the Fed rate hikes are bringing prices down as intended. Energy has retraced back to levels last seen before the Ukraine War. Utility and used vehicle prices have also retreated over the last 12 months. Rent prices remain sticky, preventing both inflation measures from feeling the full effect of the Fed’s tightening policy. When gauging inflation with recent CPI prints, we have witnessed six consecutive months of core inflation at 0.4% or higher, which has become a concern for market participants. The Fed’s preferred inflation measure, Personal Consumption Expenditures, posted +4.4% (year over year) for April 2023, steadily declining from +5.3% just five months earlier. PCE ex Food and Energy posted +4.7% for April 2023 and has been in a narrow range over the past 12 months, unable to make progress as food prices remain elevated and stubborn. We anticipate that core inflation will begin to improve as the economy continues to slow. We maintain our range of 3.0% to 4.0% for FY2023 on Core PCE.

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10-year Treasury

Rate volatility has certainly been a theme throughout the year, and the 10-year yield was not immune, with yields trading in a range as low as 3.30% and as high as 4.05%. However, more recently we have seen the 10-year Treasury fall into a narrower but elevated range around the 3.75% level. Part of this has been driven by the banking sector fear subsiding, but moreover the resilient economic data as of late has fostered an opinion that an economic recession is not a foregone conclusion. Despite a 5% Fed policy rate, labor market data has been more robust, consumer spending has maintained, and the potential for a more muted slowdown of the economy has been priced into the 10-year part of the curve. From here, it seems more unlikely that long-term rates can rise back above 4% as an economic slowdown is inevitable. Furthermore, most of the forward-looking survey-based economic data has been signaling economic weakness. At some point, perhaps in early 2024, monetary policy will likely be too restrictive and the Fed will have to cut rates. Therefore, we are maintaining our forecast for the 10-year yield to end the year within a range of 3.50% and 4.00%.


U.S. Equities

1Q23 S&P 500 earnings came in -2.6% from 4Q22, better than expected. This was positive for the equity market bulls as they look for any data point to bolster their enthusiastic viewpoint after a negative FY2022. News of artificial intelligence efficiency by Information Technology sector names excited investors recently and pushed U.S. equities to break out of their range to the upside. Large-cap growth has outpaced value by 800 basis points year-to-date according to S&P, with Information Technology names leading the way and Energy lagging. Investors seem to be looking past looming clouds on the horizon, 1Q23 S&P 500 earnings per share again declining and 1Q23 revenue growth down to a level last seen in 4Q20 according to FactSet®. We acknowledge the recent optimism but also see that U.S. equities could be challenged with potential economic uncertainty on the horizon. Despite year-to-date S&P 500 return above our expectations, it is this concern that leads us to maintain our 2023 target return on the S&P 500® Index to be -5% to 10%.


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 June 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