The pain began on 5 January with the release of the December 2021 FOMC meeting minutes. The takeaway was that investors should expect the Federal Reserve to hike rates sooner and faster than expected. That hawkish pivot drove cross-asset performance all year—the result of the Fed tightening financial conditions to slow the economy and bring inflation down. If first impressions matter, that’s a high bar for this first trading week of 2023. The December 2022 FOMC meeting minutes are released 4 January, but they won’t have the same impact with the Fed near the end of its rate hiking cycle rather than not having even started.
Instead, a different first-week data point could similarly set the tone for the year: The December jobs report on 6 January, and specifically average hourly earnings (AHE). Wages are the one big piece of the inflation puzzle that have yet to moderate, in contrast to goods inflation falling significantly and leading indicators for shelter inflation pointing to a sizeable decline by year-end. In November, AHE rose 0.6% month-over-month versus the 0.3% consensus expectation. If the December AHE falls back to around 0.3% m/m, then investors may dismiss the November result as an anomaly and the disinflation narrative would likely pick up speed. But another 0.6% m/m print? That’s a problem.
Many factors will influence market performance in 2023, but the main macro question right out of the gate is whether the labor market can cool sufficiently without cracking—hence the focus on AHE. That’s the biggest uncertainty over the magnitude of the disinflation that will occur this year, a term that could well be the finance word of the year for 2023. In turn, Fed policy will be influenced because a balanced labor market is a prerequisite for pivoting to rate cuts. The labor market’s ability to cool without cracking, and the resulting impact on Fed policy, is arguably the biggest determinant of whether the economy will experience a soft landing, a mild recession, or a deep recession.
Looking beyond the first week and the labor market, there’s no shortage of factors that will matter for financial markets this year. The war in Ukraine will continue to be a source of risks without a clear move toward deescalation. Until central banks at least pause, if not pivot, monetary policy will remain a headwind, especially after the Bank of Japan altered its yield curve control policy and with QT yet to really start to bite. More optimistically, China abandoning its zero-COVID policy means the global economy can finally move past the pandemic stage in 2023, which is consistent with prior pandemics lasting an average of 2.5 to 3.5 years.
The bottom line: The year begins with US and global growth set to slow, but with the wrinkles of a fairly resilient US consumer and China poised for an earlier-than-expected reopening acceleration. Inflation is now falling and the AHE data will either reinforce or undermine investors’ disinflation expectations. For now, the challenges of slowing growth, high wage growth, and central banks that are still tightening warrant a cautious position on the markets, at least for 1Q. Only once we start to see inflection points in these factors will market regimes really change. As in 2022, the seeds for those inflection points could sprout very early in the year.
Main contributor: Jason Draho, Head of Asset Allocation, CIO Americas
This content is a product of the Chief Investment Office (CIO).
See the original report - First impressions, 3 January 2023.
