The Week Ahead | 12/12/2022

soft landing in 2022, what about 2023

Dec 12, 2022

The Federal Reserve intended for a gradual reduction in the pace of tightening, combined with a higher terminal interest rate, would avert a large easing in financial conditions. Evidently, that has not been effective as shown by Goldman's estimation of 100bp from its recent peak. The lackadaisical inflation reports further added to the pressure for an easier monetary policy. As such, their forecasted growth deceleration in 2023 due to tighter financial conditions has meaningfully decreased.

The FOMC can take measures to prevent the recent easing in financial conditions, such as signaling another 50bp hike in February. However, I think that Fed officials would rather keep their options open at this time. The recession next year does not seem like as big of a problem to the FOCM because most other forecasters expect it too and they believe that the rate hikes will have more impact later on than we do.

Growth

I predict that GDP growth will decelerate to 0.2% in 2022 (4Q/4Q) and then fall to -0.9% in 2023 (4Q/4Q) because the delayed effects of stricter monetary policy and more difficult financial conditions will slow down the economy.

Inflation

Disinflation, or a decrease in the rate of inflation, is expected next year due to contributions from a potential recession and persistent goods deflation. I forecast that headline PCE will grow at 5.8% during 2022 (4Q/4Q) followed by 3.1% growth during 2023, with core increasing to 4.8% and then leveling off to 3.1%. Given this data, it appears that my forecast remains consistent with the Federal Reserve's target of 2% inflation by late 2024.

Federal Reserve

I expect rate hikes of 50 basis points in December and February, followed by a 25-basis point hike in March, resulting in a terminal rate of 5.0-5.25%. I believe that the risks to my revised forecast for Federal Open Market Committee policy continue to be higher than anticipated, and upcoming reports on consumer price index inflation will play a large role in shaping the short-term path for Fed policy.

The Hot Zones this week

The CPI continues to stay low, however, there are deeper issues that we need to address. The November CPI report looks promising, with an estimated increase of 0.2% m/m for headline CPI and 0.3% m/m for core CPI. Additionally, energy prices are expected to have dropped due to falling gasoline prices. In Powell's most recent speech at Brookings, he mentioned that the dynamics of core goods will continue to improve. Our research tells us that there are three main reasons core goods prices will continue to fall. Firstly, holiday discounting is higher than usual, secondly fewer people are buying during the holidays, and lastly used car prices have decreased. Additionally, we expect shelter inflation to stay high even though rental rates have been declining recently; however, this won't be reflected in CPI reports until next year at earliest. Lastly, we anticipate that core services ex-shelter inflation (which is linked directly with wages and employment) will stay elevated.

Fed: pushing back - Even though November's inflation was rather tame, it probably won't have an impact on the Fed's December rate hike plans. The terminal rates (the highest level the interest rate will be during a given cycle) is 5.0-5.25%. According to our forecast, the Fed will need to see a weakened labor market before it stops hiking rates. This is scheduled to occur in the first quarter of 2023. Last week, Powell mentioned how wage inflation affects core services inflation excluding housing costs. Therefore, we need to slow down the labor market in order for inflation rates be become more stabilized.

Economic Calendar

Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.

Briefing.com

Last Week's Numbers

Earnings

Source I/B/E/S data from Refinitiv

Aggregate Estimates and Revisions

22Q3 Y/Y earnings are expected to be 4.4%. Excluding the energy sector, the Y/Y earnings estimate is -3.4%.
Of the 498 companies in the S&P 500 that have reported earnings to date for 22Q3, 70.9% have reported earnings above analyst estimates. This compares to a long-term average of 66.2% and prior four quarter average of 78.1%.
During the week of Dec. 12, six S&P 500 companies are expected to report quarterly earnings.

Global Spotlight

Dec. 5 marks the Russian oil price cap's entry into effect. This G-7 and EU sea trade limit on Russian oil will be set at $60 per barrel with aadjustment system that guarantee it is always 5% below global prices; experts will reassess the level every two months. Prices for Russian oil will only be minimally affected as it is mostly traded at $60 per barrel. This loophole enables Russia and its patrons to bypass the price cap and still use Western financial services. If oil prices increase and the price difference between what is being charged internationally and under the cap becomes bigger, Moscow will more than likely react by reducing exports to countries and companies who still want to follow the rules of the price cap.At the same time, OPEC+ will have a meeting on December 4th about their oil policy; because there has been a recent decline in oil prices, it's possible that bloc decides to put additional production cuts on top of what was already agreed upon in October.

The presidents of Mercosur will have a summit on December 5-6 in Montevideo, Uruguay to discuss Argentina's assumption of the pro tempore presidency and other pressing issues. The biggest concern is that Uruguay is negotiating to join the Trans-Pacific Partnership outside of Mercosur. In late November, Argentina, Brazil and Paraguay issued a joint note reminding the government of Uruguay that Mercosur reserves "the right to adopt any measures they deem necessary to defend their interests in the legal and commercial spheres." Whether Uruguay will risk its relationship with its main trading partners, Argentina and Brazil by not changing their policy on cigarettes at the summit. If Uruguay were no longer part of the trading bloc, the nation would likely still have free trade agreements with various other countries in the bloc. This newfound freedom would also allow Uruguay to negotiate a free trade deal with China and Trans-Pacific Partnership nations. If this occurred, exports of soybeans--Uruguay's main good--would increase significantly.

Introducing the new Israeli government! Prime Minister-designate Benjamin Netanyahu has finalized his Cabinet after clinching deals with the Religious Zionism party. This government will be in place until at least Dec. 11. If no internal obstacles arise, the most right-wing government in Israel's history could emerge next week. The immediate goal of this new government would be to weaken the Supreme Court of Israel, which has long been a check on the Knesset. This would ensure that its social and political legislation can survive court challenges. Pro-Israel voices, including a former head of the ADL, have come out in strong opposition to this prospect, saying that it would weaken Israeli democracy and damage Diaspora support for Israel. The right-wing government's policy priorities represent only the start of their plans, which include expanding settlements and Israeli control in the West Bank, as well as enacting socially conservative policies that could target LGBTQ Israelis.

South Africa's parliament debated the president's fate on Dec. 6, one day after an independent panel released a report alleging President Cyril Ramaphosa of committing misconduct, violating the country's constitution, and oath of office concerning the cover-up of a $4 million theft from his farm. The assembly must decide whether to adopt the report, which could result in impeachment proceedings. Before the meeting, the ruling African National Congress's leadership will discuss Ramaphosa's future; although, he may resign before the assembly debates the report. If Ramaphosa leaves office, it would trigger a conflict between the ANC's pro-business and populist factions that could last until 2023. This would create doubt about South Africa's political situation and investment climate.