Interest rates continue to trade in recently established ranges but did migrate higher over the course of the week, correlated with the generally constructive economic data and next week’s Federal Open Market Committee (FOMC) meeting on February 1st. The advance report on fourth quarter GDP was released on Thursday and moderately surprised to the upside, coming in at 2.9% compared to the consensus estimate of 2.7%, but notably below the widely followed Atlanta Fed GDP Now model which predicted growth of 3.5%. The underlying details of the GDP report were mixed, with household and government spending solid, somewhat offset by a higher-than-expected inventory build, which could be a drag on growth in the first half of 2023. This morning PCE inflation was released and more or less came in at expectations, with the PCE Deflator at 0.1% month-over-month and 5.0% year-over-year, a drop of 0.5% from the prior annualized number, and the PCE Core Deflator coming in at 0.3% month-over-month and 4.4% year-over-year, a drop of 0.3% annualized. Notably, in Chandler’s view, weekly jobless claims remain quite low, most recently at 186k per week, well beneath the 250k caution area. The totality of the recent data remains consistent with an outlook for positive, but below trend growth in the first half of 2023, with the trajectory of the economy not yet approaching stall speed.
Next week the FOMC meets, and the Chandler team is in agreement with the market consensus that the Fed Funds rate will be increased by 25 basis points to a new range of 4.50% to 4.75%, with policymakers indicating further increases are likely. We do think we are approaching the point where interest rates will be restrictive enough for the Federal Reserve to pause in their hiking campaign and continue to forecast a Fed Funds rate of around 5% is the proper level of restriction, but notably we think it is premature to price in an easing of policy early in the third quarter of 2023. Assuming our forecast on moderating inflation comes to fruition, a ‘fine tuning’ lower of the Fed Funds rate is likely in 2024. Until the FOMC is clearly able to indicate a pause in tightening policy, we expect market volatility to persist. We also believe short end interest rates are poised to move higher, as the current spread between the two year Treasury note, at 4.21%, compared to an anticipated Fed Funds rate of approximately 5%, is too low. Next week significant top tier economic data will be released, including the ISM Manufacturing and ISM Services Indices, as well as an update on the employment situation at the end of the week. The team will be acutely focused on job growth, the unemployment rate, and wage inflation, to corroborate or discount our views on the outlook of the economy in 2023.
Next Week:
Employment Cost Index, S&P Core Logic Home Price index, Chicago PMI, Consumer Confidence, ADP Employment, ISM Manufacturing and ISM Services Indices, JOLTS, and the January Payroll report.
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© 2023 Chandler Asset Management, Inc. An Independent Registered Investment Adviser. Data source: Bloomberg, Federal Reserve, and the US Department of Labor. This report is provided for informational purposes only and should not be construed as specific investment or legal advice. The information contained herein was obtained from sources believed to be reliable as of the date of publication, but may become outdated or superseded at any time without notice. Any opinions or views expressed are based on current market conditions and are subject to change. This report may contain forecasts and forward-looking statements which are inherently limited and should not be relied upon as an indicator of future results. Past performance is not indicative of future results. This report is not intended to constitute an offer, solicitation, recommendation, or advice regarding any securities or investment strategy and should not be regarded by recipients as a substitute for the exercise of their own judgment. Fixed income investments are subject to interest rate, credit, and market risk. Interest rate risk: The value of fixed income investments will decline as interest rates rise. Credit risk: the possibility that the borrower may not be able to repay interest and principal. Low-rated bonds generally have to pay higher interest rates to attract investors willing to take on greater risk. Market risk: the bond market, in general, could decline due to economic conditions, especially during periods of rising interest rates.