Resilient Economy Means the Fed Will Not Pivot 

1. Labor Market Drives Consumer, Which Drives Economy. The latest economic data points to a resilient economy. 683,000 new home sales in April 2023 was the highest level since March 2022. Despite 30-year fixed mortgage rates crossing above 8%, the housing market remains driven by secular themes, providing a positive multiplier for many parts of the economy. 

Industrial production increased +0.5% m/m in April, surpassing expectations of 0% growth. This expansion in industrial production is an encouraging sign, as it indicates positive momentum in the manufacturing sector. Additionally, capital goods orders, excluding aircraft, remains a key indicator of business spending and a direct component in GDP and continues to show strength, further supporting the overall economic outlook. 

The consumer remains a pillar of strength in the economy. Consumer spending in April rose by +0.8% m/m, doubling expectations of 0.4%. This robust consumer spending demonstrates the resilience and confidence of households and represents 70% of GDP. Consumer spending on services is 9% above its pre-pandemic trend and twice as big as consumer spending on goods. 

Chart 1: Industrial Production and Personal Consumption Expenditures Stay Resilient in 2023¹ 

Strength in the labor market is driving a healthy consumer. Initial jobless claims remain low, indicating a tight labor market with fewer layoffs. Nonfarm payrolls and job openings (JOLTS) data also point to a strong job market. These indicators suggest that businesses are actively hiring, further supporting consumer spending and economic growth. In fact, the labor market is diverting more high school graduates away from college and towards the blue-collar labor force. 

Chart 2: Elevated Job Openings, Low Initial Jobless Claims² 

Average hourly earnings for leisure and hospitality workers were up +30% in April from the same period in 2019 (pre-pandemic). Wages for all workers were +20% on aggregate over the same time period. College graduates are facing a challenging labor environment as companies rethink their need for high-cost white-collar jobs, while blue-collar jobs are widely available and offer attractive pay. College enrollment is down -15% over the past decade.³ 

Inflation remains a significant concern in the current economic landscape. The Personal Consumption Expenditures (PCE) deflator, the Fed’s preferred measure of inflation, rose +4.4% y/y. Inflation pressure is highlighted in rents; utilities; auto maintenance and leasing; food services; and select health care categories like dental, nursing home and veterinary services. The elevated level of inflation is sticky, indicating that price pressures are persisting and have not subsided to the Fed’s target levels. 

Chart 3: Consumer Pricing Remains Elevated⁴ 

Given the persistent inflation, the Fed has maintained its stance of keeping interest rates higher for longer. There is no indication of a pivot in the near future, suggesting that the central bank is committed to managing inflationary pressures and maintaining price stability. 

The Atlanta Fed’s GDP Now forecast projects a +1.9% q/q GDP growth rate for the second quarter, still indicating a solid expansion in the economy, despite the restrictive monetary policy and bank lending. Alternative asset managers, sometimes referred to as “shadow banks,” have managed to capitalize on the banking turmoil in areas like private lending, and are not exposed to deposit runs. Many of these managers maintain a high level of dry powder for investing, yet capital raising has slowed throughout the past year.⁵ 

The current economic environment remains resilient, driven by a strong consumer, a tight labor market and persistent inflationary pressures. Positive economic indicators, such as new home sales, industrial production, and consumer spending, reflect the ongoing strength of the economy. However, the elevated level of inflation poses a challenge, and we expect the Fed to maintain restrictive policy throughout the year. 

2. Defensive Sectors Underperforming. Despite the overall strength of the economy and positive market sentiment, defensive sectors have been underperforming, as market participants are not anticipating a recession. Defensive sectors, traditionally sought-after during periods of economic uncertainty, have underperformed in recent weeks. Declines in the ISM Manufacturing index tend to create a shift towards defensives, like consumer staples, and, while lower, the index has most recently surprised to the upside. 

Investors have been favoring more growth-oriented sectors, such as the technology and consumer discretionary sectors, as they bet on continued economic expansion. Getting past the debt ceiling deadline will also bring further clarity in signals from equity and bond markets, alike. 

Chart 4: Just Three Sectors Outperforming Year-to-Date: Tech, Comm. Services, Discretionary⁶ 

3. Debt Ceiling Deal. President Biden and House Leader McCarthy have agreed on a bill to extend the debt ceiling through 2024. Democrats agreed to cap federal spending for the next two years. The deal is expected to pass both the House and Senate. The bill must pass before June 5 to avoid a government default. 

4. Higher Yields Across the Curve. Over the past two weeks, treasury yields have marched steadily higher. While visible across the entire curve, the short end has seen a more aggressive move. The 2yr/10yr spread widened from -40 bps in early May to -80 bps as of Friday’s close. The 2yr yield rose 30 bps to close the week at 4.56%, while the 10yr yield closed the week at 3.79%. High yield spreads closed the week at -483 bps, well tighter than the -600 bps spread witnessed last summer, however, still wider than spreads prior to the bank collapses in March. 

5. The Week Ahead. 

Earnings – Tuesday: HPQ, HPE. Wednesday: CRM. Thursday: DG, AVGO. 

Economics – Tuesday: S&P Case-Shiller (March), Consumer Confidence (May), Dallas Fed Index (May). Wednesday: JOLTS Job Openings (April), Chicago PMI (April). Thursday: ADP Employment (May), ISM Manufacturing (May). Friday: Hourly Earnings (May), Unemployment Rate (May), Nonfarm Payrolls (May). 

Stephanie Link: CNBC TV Schedule 

Return for Selected Indices⁷ 

Sources

1. FactSet (chart). As of May 29, 2023.
2. FactSet (chart). As of May 29, 2023.
3. The Wall Street Journal. As of May 29, 2023
4. FactSet (chart). As of May 29, 2023.
5. The Wall Street Journal. As of May 29, 2023.
6. FactSet (chart). As of May 29, 2023.
7. Bloomberg. As of May 29, 2023.

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