Financial News for the Week of January 20th, 2023

The week started with a holiday, but that didn’t stop markets from feeling the blues of the most depressing period in the Northern Hemisphere in financial news. At the time of writing, equities are down almost 2% on the week. On the political front, concerns about the government’s ability to pay its debts resurfaced as the Treasury Department was forced to begin taking ‘extraordinary measures’ in order to keep paying the government’s bills. By suspending certain additional investments, the Treasury buys Congress more time – likely until June – to negotiate a resolution on how to increase the debt ceiling. With the deadline still several months out, investors’ focus was squarely on the economic data. Unfortunately, there was little to cheer about.

Retail sales came in weaker than expected – falling 1.1% m/m – and marking the second consecutive month of declines.  Most major categories were weak in both nominal and inflation adjusted terms. The only group that showed stronger demand was sales at gas stations, where real sales rose five percentage points on a sizeable drop in gas prices (Chart 1). The message is clear: consumers are becoming increasingly more cautious in allocating their income and pandemic savings. Moreover, judging by sales at restaurant and bars, demand for services might also be nearing an inflection point.  The soft reading on retail sales led us to adjust our expectations for Q4 consumer spending down to a still robust 2.7% (previously 3.3%).

Housing activity also ended 2022 on a soft note. Residential construction declined for the fourth consecutive month, but by less than expected in December. The decline was attributed to a 19% drop in the multi-family segment. In contrast, starts in the single-family, rose for the first time in four months, but are likely to decelerate further in the months ahead as permits continue to trend lower (Chart 2).

On that note, existing home sales also continued to soften, falling 1.5% m/m December and 17.8% for the year. Despite the sharp decline in sales, prices have only fallen by 1.5%. However, the sharp increase in inventory since August suggests more meaningful downward pressure lies ahead.

Increasingly bold signs of cooling economic activity are welcome news for the Fed on its mission to bring down inflation. That said, this week’s Fed speakers had varying degrees of hawkishness on the pace of upcoming rate hikes. Of those who have the voting rights on the Federal Open Market Committee, James Bullard sounded most hawkish by expressing his preference to “err on the tighter side to get the disinflationary process to take hold”.

In contrast, Fed’s Lorie Logan and Patrick Harker voiced their support for a 25-basis point hike, while Vice Chair Lael Brainard, without explicitly backing a softer pace, emphasized the possibility of a soft lending – easing in the labor market and reduction in inflation without a significant loss of employment in further financial news. Markets side with this view, having priced-in a quarter-of-a percent hike on February 1st with a 97% probability. Compare it to exactly one month ago, when only 70% of market participants (including yours truly) expected a downshift. Seemingly, investors express more certainty about an economic slowdown ahead.

 

Maria Solovieva, CFA,  Economist | 416-380-1195