This week provided more evidence that the US economy remains on track for a soft landing—a scenario when growth stays positive, the labor market remains balanced, and inflation converges to the Federal Reserve’s long-term target of 2%. Additional data points show US wages and consumption remain resilient and corporate earnings continue to positively surprise in the background, albeit with a few warnings of slowing growth. The past calls for recession seem to be fading into a distant memory, with many investors and economists turning their outlooks more positive. With a Federal Reserve meeting next week, the stage is set for interest rate cuts to begin later in 2024. The markets continued its melt up. The S&P 500 Index closed the week higher by 1.1%, and the Bloomberg US Aggregate Index modestly increased 0.1%.
The US economy posted a better-than-expected Q4 GDP growth of 3.3% annualized, resulting in a full-year 2023 GDP growth of 2.5%. The positive GDP surprise flies in the face of recession calls from 2022 when economists predicted the Federal Reserve’s tightening cycle would push the economy into contraction territory. Consumer spending, up by 2.8% in Q4, served as the primary driver of GDP growth throughout 2023, while contributions from business investment and housing were also notable. Fed officials will be dissecting the data ahead of their meeting next week, but they will likely be more focused on the growth trajectory into 2024 before making any rate decisions. In addition, the Atlanta Fed’s GDPNow forecast—a real-time estimate of current quarter GDP—projects growth at 3% annualized. Historical and projected figures underscore a resilient economy and suggests easier policy conditions are unnecessary.
Personal consumption has been a major contributor to GDP throughout 2023
GDP Contribution (%)
Source: Bloomberg. As of December 31, 2023.
Core inflation numbers remain subdued despite strong consumption, a robust labor market, increasing business investment, and positive economic growth. On Friday, the Federal Reserve’s preferred inflation gauge, the core personal consumption expenditure deflator (PCE), showed a month-over-month increase of just 0.2% and a year-over-year increase of 2.9%. The recent trend has now fallen below the Fed’s full-year target—the three-month annualized pace of core inflation fell to 1.5%, and the six-month pace remains at 1.9%. According to the forward estimates, this trend is also expected to continue.. While the past 12-month figure remains less favorable, investors hope the Fed puts more weight on the most recent readings and pulls a rate cut forward.
Inflation’s sharp decline: On the path toward the Fed’s 2% target
PCE YoY
Source: Bloomberg. As of December 31, 2023.
Finally, things look far less positive in China compared to the US. Recent data suggests several short- and long-term headwinds for the world’s second-largest economy, resulting in capital outflows during a period of lower growth prospects. In stark contrast to US markets, this month’s heavy selloff brings China’s index down 40% over the past three years, leading to record levels of investor pessimism and elevated capital outflows. Chinese investors and consumers have grappled with ongoing real estate market turbulence and bouts of price instability, including the worst streak of deflation in nearly 25 years. Local economies are also struggling, marked by declining exports, elevated youth unemployment, and over indebted local governments. The troubles have caught the attention of policymakers and Chinese Communist Party (CCP) leaders are preparing far more robust measures than those taken in the past. Last week, the CCP announced it was considering a $278B (~2T Yuan) rescue package to stimulate local economies. The implications for global investors remain to be seen, but global growth will likely be challenged without contributions from China.
China’s $6T market rout sits in stark comparison to US markets
MSCI China Index vs MSCI USA Index
Source: Bloomberg/MSCI. As of January 26, 2024. Past performance is no guarantee of future results.
– Written by Eric Schmitz, CFA