First-quarter 2023 economic outlook with Jim Solloway
Excess demand is keeping inflation at elevated levels far longer than most have expected.
Solloway Q1 2023 economic outlook
Jim Solloway, Chief Market Strategist and Senior Portfolio Manager for the IMU Advice Group, presents our economic outlook for the coming months.
- Hello, I'm Vivian Estadt, client service director at SEI. I'm here with chief market strategist and senior portfolio manager Jim Solloway who will present SEI's economic outlook. Jim, the first quarter of 2023 saw a repeat of many of the themes witnessed at the end of 2022, high inflation, tight labor markets, central bank policy action and questions about the likelihood of a global recession. It also surprised us with a banking crisis and subsequent bond market volatility. As a result, there was a lot of uncertainty about the trajectory of growth and inflation and the fragility of the financial markets. What do you make of the current environment and where do you see us headed?
- Thanks, Vivian. We can envision a scenario where economic growth slows but not enough to push inflation back to the 2% target rate that the Federal Reserve and other major central banks have set as their goal.
- Market consensus is that central banks will cut interest rates and inflation will begin to abate within the year. How does that compare to your view?
- We believe that markets are probably getting ahead of themselves. Cyclical factors, namely tight labor markets and consumer resiliency, along with secular factors, a persistently tight labor market, a focus on supply chain resiliency and high capital and non-labor operating costs suggests to us that inflation will remain higher than what central banks and market participants expect. The first three months of 2023 have surprisingly shown economic strength globally. Consumer spending has stayed buoyant because employment trends have been strong this year.
- You mentioned labor markets as both cyclical and secular factors. How does this contribute to your view on inflation?
- The labor market remains the tightest in the service sectors where spending appears to be the strongest, namely hospitality, professional services and healthcare. Excess demand is keeping inflation at elevated levels far longer than most have expected. So currently reported unemployment rates are at or below long-term equilibrium levels for many countries, implying that labor markets are extremely tight and wage growth is likely to remain higher than desired.
- While high inflation and central bank policy measures remain at the top of mind going into the first quarter, in the past few weeks, we witnessed a liquidity squeeze and the collapse of several high profile US financial institutions, as well as the takeover of Switzerland's Credit Suisse. The crisis doesn't seem to be dissuading central banks from pursuing their inflation-fighting goals. How do you see banks balancing efforts to curb inflation while simultaneously ensuring financial stability?
- It will most certainly be a challenge. Both the European Central Bank and the Fed pushed ahead with inflation fighting rate hikes during the quarter. We expect that growth will slow but not enough to push inflation back to the 2% target that the Fed and other major central banks have set. Policymakers will have to decide between controlling inflation and supporting financial stability.
-The latest projections of the federal open market committee still call for one more rate hike and no rate reductions until next year. However, future markets have priced in a series of cuts before the end of the year.
- The Federal Funds rate futures curve has swung dramatically in just three months with expectations at the start of the year that the central bank will cut rates in the second half of 2023. Before the bank failures, the entire futures curve had shifted upward in dramatic fashion. The Fed Funds futures curve now has been reset well below where they were at the start of the year. The Fed could indeed blink and cut rates as the futures curve implies but the surge of liquidity being injected into the banking system may well make the job of bringing inflation down that much harder. If push comes to shove, we expect them to choose financial stability, leaving the inflation fight for another day.
- Thanks, Jim for sharing your perspective. Read our latest economic outlook for more of SEI's insights.
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