December is the sixth consecutive month of slightly negative money growth in the United States. The traditional six- to nine-month lag in monetary effect suggests an economic downturn will arrive within the next few months—if it hasn’t already.
Although inflation should moderate, we do not expect enough of a slowdown in inflation to deter the Fed from its plan to continue to raise interest rates.
The Week That Was
November retail sales were down 0.6 percent. This puts November sales up at only a 3.4 percent annual rate from the third quarter average. With November core inflation up at a 4.3 percent pace, real retail sales in the fourth are down close to 1 percent.
Retail sales data are highly erratic and subject to substantial revisions. However, the Fed’s
November measure of manufacturing output was also down by about the same amount.
The good news this past week was for November’s CPI: up 1 percent, with core inflation up 2.5 percent, annualized. Compared to the third quarter, November inflation was up at 4.3 percent annualized, while the year-over-year increases were 6 percent to 7 percent.
Despite two months of lower inflation, the Fed cautioned against becoming too complacent. The board’s governors raised their estimates for inflation in 2023 as well as their expectation for the fed funds rate. They also lowered their growth estimates. The Fed
currently expects the fed funds rate to peak at between 5.1 percent and 5.4 percent this coming year.
The Fed’s latest estimates now are consistent with our forecast of persistent inflation and the need for more interest rates hikes. From our perspective, Powell said all the right things.
Other economic numbers remain mixed. The Fed of Atlanta model uses current economic data to estimate real growth. The data show fourth quarter real growth at a 2.8 percent annual rate.
Weekly unemployment reports were little changed. The labor market is a lagging indicator and will be the last market to point to a downturn in the economy.
Things to Come
Later this morning the S&P will report its advance estimate of business activity in early December. In contrast to other data, S&P’s estimates show the economy declining in the three months ending in November. It will be interesting to see if there is any change in their December survey.
On Monday, Homebuilders will report on early December housing activity. We expect they will report a low reading close to November’s 33.
The most important upcoming item is Thursday’s report on November consumer spending, wages, and inflation. We expect current-dollar spending and income growth to remain in the vicinity of 5 percent, with consumer inflation in the 4 percent vicinity.
Money, Money, Money
Financial markets reacted negatively to the Fed’s latest comments and interest rate decision. Chairman Jerome Powell said the Fed raised its expectation for the peak in interest rates necessary to restore inflation to 2 percent. Markets had previously anticipated a lower top in interest rates or even a pause with lower interest rates later in 2023.
Markets now assume the Fed’s intended policy is more likely, and the risks of a downturn in the economy are greater.
Market Forces
After reaching major technical resistance at 4,100, stocks have turned sharply lower. The S&P500 is down 5 percent from its recent high and 19 percent from its all-time high. Potential support now is at 3,860.
Unlike previous setbacks, which were often accompanied by higher interest rates, the latest
downward move in stocks has been with a combination of higher short-term rates and lower longer-term rates.
Wednesday’s economic news from the Fed reinforced concerns over an impending economic downturn. November retail sales and the Fed’s manufacturing index both were down at 7 percent annual rates. USEIA reported fuel consumption in the last four weeks is down 7 percent from a year ago—another indication demand is falling.
The decline in activity we have been expecting during the first half of 2023 might be arriving sooner. However, other data still are pointing to moderate fourth quarter growth.
Stocks remain overvalued, and the Fed continues draining money from the economy. With an economic downturn soon to become apparent, further downward pressure on stocks is likely.
Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 22 percent
Monetary Policy: restrictive
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