March 1, 2023




     The final quarter of 2022 ended with considerably less economic momentum than when it began. The financial markets believed the Fed’s 450 basis points of rate hikes were having the intended effect on the economy and inflation and led the markets to expect eventual rate cuts in the second half of this year. Upbeat January data releases, however, have given way to cautious optimism for the likelihood of a soft landing, causing the treasury market to re-assess and reprice those expectations after having fought the Fed for a long time.  

 Labor Market Tightness

    The FOMC elected to again slow the pace of rate increases, raising the targeted fed funds range by 25 basis points on February 1. Highlighted data since that meeting shows that the Fed’s work is far from done. The labor market added 517,000 jobs in January, bringing the unemployment rate down to a 53 year low of 3.4%. Retail sales rebounded at the start of the year, rising 3%, a full percentage point stronger than expected, after declining in three out of the last four prior months. The January Consumer Price Index (CPI) was up 0.5% month-to-month and 6.4% year-over-year. Core CPI (excluding food and energy) was also buoyant rising 0.4% for the month and 5.6% year-over-year. More inflationary pressure was also exhibited in the Producer Price Index (PPI). The headline measure rose 0.7% month-on-month while core gained 0.5% on the month. Additionally, both the headline and core Personal Consumption Expenditures (PCE) Deflators, the Fed’s favorite inflation gauge, accelerated in January from upward revised figures in November and December. Finally, manufacturing output rose by the most in nearly a year, but a warm January led to a record plunge in utilities causing overall industrial production to be flat.

Leading Economic Indicators

    Not all the economic news has been upbeat. Surveys of sentiment of small businesses and consumers remain downbeat. The Fed’s strategy to open up some slack in the economy is feeding concern on the outlook for job security, income and demand. The slump in the housing market is ongoing, the 10th consecutive monthly decline in the Leading Economic Index and inverted yield curve are predicting a recession.

Yield Curve

    Although risks remain, the economic landscape has improved since year-end. The Fed is hoping to pull off a soft landing and has laid out a plan of getting policy to a sufficiently restrictive setting and then keeping it there until they are thoroughly convinced inflation is being subdued. The Fed has remained on script, warning that the strong labor market and the process of getting inflation down is likely to be a bumpy path and take time. Market expectations have now shifted the peak fed funds rate being higher, and remaining higher for longer, than previously thought. The markets now anticipate the FOMC to press ahead with 25 basis points higher at the next two meetings before the central bank turns towards an extended pause, and data dependency mode.