Soft Growth: A US Macroeconomic Update

Despite fears of a potential recession, consumer spending continued to be boosted by the post-holiday season, albeit at a more tempered rate, which helped the economy marginally expand amid high prices. Continued government spending helped drive spending levels, keeping GDP elevated in the quarter. In turn, real GDP has been adjusted to grow an annualized 1.1% in the first quarter of 2023.

The Federal Reserve has continued to hike interest rates to help combat rising inflation, a common theme in much of last year's hikes that have carried over into 2023. However, discussions on whether future hikes are needed have played a role in the levels of growth experienced this quarter as investors remain cautious about whether the economy will have a harder or softer landing after this inflationary period. With no immediate signs of an instant recovery in 2023, much of this economic growth in the period has been mediated.

Labor market

• Although recession concerns have persisted, 885,000 million nonfarm jobs were gained in the first quarter of 2023, with an additional 253,000 jobs added in April alone.
• Education and health services, government, and leisure and hospitality propelled quarterly growth in total nonfarm employment. However, employment information and financial activities fell amid a string of layoffs.
• The unemployment rate has remained historically low due to a shrinking labor market. At the same time, layoffs continue at companies including Amazon, Apple, Meta, Lyft, Facebook, Google, IBM, Morgan Stanley and Twitter. In April, the unemployment rate stood at 3.4%.
• Although average hourly earnings increased to $33.36 in April, wages have remained pressured by inflation, with consumer spending power remaining pressured.

Consumer Spending

• Personal consumption expenditures (PCE) grew 2.1% during the first quarter of 2023 and 6.2% year-over-year as of March 2023. Consumer spending was buoyed by growth in durable goods, which increased the most out of any sector in the quarter, while services continued to prop up PCE.
• Spending on durable goods climbed 3.7% in the first quarter of 2023. Within the durable goods segment, spending on motor vehicles and parts and other durable goods increased by 8.2% and 2.6%, respectively. While the previous quarter was plagued by mounting inflation, the first quarter was marked by improved inventory levels of new cars which helped ease supply chain issues. At the same time, moves to cut electric vehicle prices by industry automakers also helped keep sales elevated.
• Spending on nondurable goods increased by 0.6% during the first quarter, with a 0.8% increase in food and beverages purchased for off-premises consumption. However, a 4.4% drop in spending on gasoline and other energy goods kept growth in this sector tempered in the quarter.
• Spending on services increased 2.0% during the first quarter of 2023, driven by increasing consumption of recreation services (3.5%) and transportation services (3.2%).

Inflation

• Personal Consumption Expenditures price index (excluding food and energy), the Federal Reserve's preferred inflation measure, increased 1.2% in the first quarter of 2023, bringing year-over-year inflation to 4.6% for the year ending in March 2023. Comparatively, inflation, as measured by the Consumer Price Index (CPI) and including food and energy items, increased 5.0% for the year ending March 2023. CPI is consumers' more common inflation figure as food and energy are major household spending categories.
• CPI increased just 0.1% in March, as a 3.5% drop in energy counteracted growth in all other items, less food and energy. Although the energy index decreased from last year, year-over-year growth has remained strong for energy services, surging 9.2% over the past 12 months.

Residential trends

• Stemming from rising inflation that has kept home prices elevated, the number of new housing units being constructed grew by 1.5% in the first quarter of 2023, compared to 3.3% in the fourth quarter of 2022.
• Mortgage rates remained volatile in the quarter while remaining elevated from last year, keeping the residential construction market in flux, mainly as interest rate hikes left investors reluctant to scale up more large-scale projects.
• Residential construction primarily declined in the quarter, falling 3.6% in the period and 9.8% from last year as mortgage rates remained higher than last year despite brief declines early in the period, kept consumers weary from making heftier investments especially compared to when interest rates were lower in the previous years.
• Despite these trends, not all residential sectors suffered declines as construction of new private multifamily homes grew 0.7% in the quarter. This growth helped combat declines experienced in private single-family housing construction, which shrunk by 1.3% in the same period stemming from mortgage rates rising. Further contributing to these trends was the value proposition of building multifamily housing, which can generate more income for investors than relying on housing leveraged with mortgage payments accrued over a longer period than rent.

Non-residential trends

• Nonresidential construction grew 2.8% from three months ago, attributed to the growth experienced in conservation and development, manufacturing, and sewage and waste disposal.
• Not all sectors experienced growth in the quarter, as commercial construction shrank 1.6% due to various factors. The continuation of remote work policies has given more flexibility to workers in choosing where they can work. Meanwhile, recent tech layoffs impacted many companies relying on office buildings to retain their operations, mitigating demand for more commercial property construction.
• The continued need for necessary infrastructure helped expand construction for conservation and development, especially as environmental concerns remain a priority for the current Biden Administration, which allocated $135.0 million in March 2023 for states with abandoned mines, adding to the last year of other projects financed through the Bureau of Land Management.
• The continuation of consumer activity in the period boosted construction activity at manufacturing facilities, especially as the consumption of durable and nondurable goods climbed despite inflationary trends, incentivizing related industries to expand their operations, resulting in this sector growing 4.3%.
• The $1.2 trillion Infrastructure Investment and Jobs Act (IIJA) continues to contribute to overall nonresidential construction spending as activity in many public projects from transportation, power, highway, and street and water supply sectors increased compared to three months ago.

Financial markets

• Increased inflation, driven by supply and demand imbalances, resulted in interest rate hikes and a tumbling stock market. However, signs of inflation easing, less aggressive interest rates and company performance have enabled positive returns in the major market indices. In the first quarter of 2023, the S&P500 returned 4.1%, NASDAQ 9.6% and DIJA 0.2%. Volatility in the market is anticipated to continue until the Fed's monetary guidance omits rate hikes.
• The Federal Reserve continued to raise rates to combat elevated inflation. At the end of the first quarter, the Fed raised the federal funds rate target by 25 basis points to 4.75-5.00%. In their most recent meeting in May, the effective federal funds rate was raised an additional 25 basis points, bringing the rate to 5.00%-5.25%. Starting in June 2022, the FOMC began reducing its securities holding and will continue to do so to reduce the money supply within the economy. Current projections have interest rates falling in 2024. However, if additional inflation risks occur, the committee will tighten its monetary policy through aggressive interest rate hikes.
• Fear of a looming recession weighs heavy on investors' minds as company performance continues to be impacted. While Jerome Powell stated the disinflationary process started in the February update, the most recent guidance is that interest rates will not be lowered soon. The market remains highly volatile as inflationary concerns and global uncertainty remains elevated.
• The trade deficit rose 12.2%, heavily impacted by foreign supply chains out-performing domestic production. Consumers increased their purchases of imported goods, boosted after the height of the pandemic. In response to rising import volume, the Biden administration incentivizes companies to change supply chains, primarily by adding more barriers to trade with China.

Distribution of risk ratings

• Nearly half of the industries were at medium-high or higher risk in 2020 due to the onset of the pandemic and resulting business closures throughout the economy.
• Following heightened risk at the start of the pandemic, risk levels tempered in 2021 as restrictions eased, resulting in 22.4% of industries rated as a medium-high or greater risk.
• High inflation, recession fears and supply chain bottlenecks resulted in higher risk levels in 2022, bringing 34.7% of industries rated as a medium-high or greater risk.
• Risk levels are expected to worsen in the outlook amid ongoing inflation concerns, interest rate hikes and worsening recession fears. Consequently, 54.0% of industries are rated as medium-high or greater risk in 2023 and 44.4% as medium-high or greater risk in 2024.

Sector highlights

• Mining – Inflationary trends continue to harm energy-reliant sectors like mining, which heavily rely on energy sources at more significant swaths of quantity to power and fuel essential machinery. While energy prices have dropped in the quarter for gas, they remain higher than last year, which remains a pressure point on mining companies that must endure high costs to maintain their output. Rising concerns of an impending recession have continued to raise interest rates, negatively hitting construction industries alike, hurting growth for more metals mined from this sector to be used in large-scale projects and more products in general. In turn, the international appetite for more energy is set to be tempered by continuing rising prices in which a recession curtails potential growth from consumers that want to save even more or can opt to use electricity instead, threatening both the Oil Drilling & Gas Extraction and Copper, Nickel, Lead & Zinc Mining
• Real Estate and Rental and Leasing – Scaling interest rates have increased mortgage costs, which has played a role in troubled growth rates for the real estate and leasing market. Vacant office spaces starting with the avalanche of the remote work phenomenon have gutted cities with large-scale commercial businesses nearby, contributing to the value of these properties plummeting with fewer people commuting to work or choosing to work remotely. Inflation has also increased property maintenance costs, further deterring consumers from obtaining mortgages and hurting real estate markets. Concurrent recessionary fears in 2023 are set to loom over markets as no signs of an immediate recovery are in sight, leaving the Real Estate Sales & Brokerage and Land Leasing industries pressured in the coming years.
• Agriculture, Forestry, Fishing and Hunting – Inflation and environmental factors have also been a pressure point for crop growers, impacting production rates and keeping stresses on supply chains. Volatile weather patterns that occurred in the previous year with the concurrent drought and unnatural occurrences like citrus greening and the bird flu present a supply problem for crop and cattle growers that must endure losses on their output or prepare for potential ones. With the inflationary environment promoting consumers to save rather than spend, higher agricultural goods prices will further deter consumers. In turn, these trends are set to keep this market at bay, with the potential for a recession hitting sooner than later, leaving the Beef Cattle Production and Corn Farming industries pressured in the coming years.

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