by Jade Thomason
Equity and Fixed Income Trader
This week marks the start of earnings season and investors are anxiously awaiting corporate guidance to shed light on the state of the economy. The first quarter of 2023 brought positive returns for both stocks and bonds, but we also saw the second and third largest bank failures in U.S. history. Mixed signals like this are difficult for investors to reconcile, however, this week was rich with economic data to set the stage for the second quarter of 2023.
Fed Meeting Minutes
On Wednesday, minutes from the March 22 Federal Open Market Committee (FOMC) meeting were released and offered insight into the discussion that led to a quarter-point increase of the federal funds rate. The banking-sector news in early March caused Fed officials to contemplate a pause in rate hikes, but actions by regulators alleviated acute concerns, and the Fed proceeded with the hike. This was the ninth increase over the past year and brought the federal funds rate to a range between 4.75% and 5%. The minutes also disclosed their perspective on the timing of a future recession and why additional rate hikes are necessary. The meeting summary stated, “Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years.” Prior to the banking crisis, the Fed staff predicted a recession was not likely until next year. A sticking point for the Fed is the strength of the labor market and stubborn inflation, which puts upward pressure on prices and keeps the 2% target for inflation out of reach. Due to the continued strength of the economy, the odds of a quarter point hike in May are currently 68%.
Consumer Price Index (CPI) Release
The Topline Consumer Price Index (CPI), a measure of inflation, dropped in March for the ninth consecutive month to its lowest level in nearly two years. CPI rose 5% last month from a year earlier. This is down from February’s 6% increase, but still well above the Fed’s 2% target. Slightly elevated from the prior month is the Core component of CPI, which is an underlying measure that excludes both food and energy. The graph below segments the components of inflation as either goods or services.
As noted by the gray bars, food and energy are the more volatile components of CPI and their contribution to headline CPI has been rapidly declining since June. This lower trend for the price of groceries, gasoline, and utilities continued last month while shelter remained the sticky piece within Core Services. The plateau seen in the Core Services component is encouraging and is what the Fed needs to see to pause rate hikes. Similar to CPI, the Producer Price Index (PPI) is a measure of inflation but at the supplier level, not the consumer level, and tracks the weighted average price of all “first-stage goods”, i.e., lumber or metals. These products are sold to businesses and used to create the final product, which is sold to consumers. This index displayed the same pattern as CPI and decreased to 2.7% in March, which was a dramatic improvement from 4.9% in February.
What Now?
The data highlighted above demonstrates that the economy is cooling, and the Fed’s agenda is starting to take shape. We still believe any recession will be short and shallow, and based on the Fed minutes, may occur sooner than previously anticipated. Regarding earnings season, first quarter profits are projected to drop 6.8% from a year prior, which would be the largest earnings decline since the second quarter of 2020. Investors are looking to these reports to gain insight into the remainder of 2023 and how companies will be able to manage profit margin pressures resulting from above-trend inflation.
Takeaways for the Week:
CPI, a measure of inflation, dropped in March for the ninth consecutive month to its lowest level in nearly two years.
This week marks the kickoff for the corporate earnings season and will demonstrate how companies have navigated the challenging economic environment.