MANHATTAN (CN) — Notching incremental gains all week, Wall Street rallied on various economic reports suggesting the economy is slowing at a manageable rate and that inflation is cooling.
In particular, good news on gross domestic product released on Thursday showed U.S. gross domestic product grew by an annual rate of 2.9% last year, better than most had predicted, and 2.1% real GDP growth for last year showed a strong economy overall. Personal income increased $311 billion in the fourth quarter of last year, compared with an increase of $283.1 billion in the third quarter, the report found.
The S&P 500 reacted to the indication from the report of a looming — but probably manageable — recession by closing Thursday at a new six-week high. By the week’s end, the S&P had gained 98 points, while the Dow Jones Industrial Average netted 602 points and the Nasdaq increased by 481 points.
Consumer spending appears to be waning, with signs as well of a likely drop in business investment — capital expenditures increased only 0.7% last quarter versus a 6.2% increase in the third quarter — but Wall Street is banking on a soft landing, in which the harsh measures taken in 2022 to combat rampant inflation will bring about only a mild recession.
“Right now this is a ‘glass half full market,’ and investors viewed [recent] solid data as implying the U.S. economy is stronger than expected,” Tom Essaye of the Sevens Report wrote in an investors note on Friday morning. “As such, a hard landing is seen as less likely than before.”
Essaye said investors will be particular focused on bond yields and less on GDP data, which he says typically is backward looking and not a useful metric in predicting future economic growth. “For the ‘soft landing’ thesis to be intact and for markets to see continued gains and be led by tech and growth, we must see yields continue to decline, and that will require a less-hawkish-than-expected Fed next week,” Essaye wrote.
Following the good news on GDP, the newest inflation data released on Friday by the U.S. Bureau of Economic Analysis showed that personal consumption expenditures increased by just 0.1% for the second consecutive month. While the report is good news for inflation, it hints that the economy is already shrinking.
Bill Adams, chief economist for Comerica Bank, meanwhile held up a number of recent negative data points as cause for concern: the fact that real fixed investment fell for the third consecutive quarter, continued unemployment insurance claims are now up 26% in the last six months, and the yield curve is such that the government could borrow for a cheaper interest rate for 10 years than for shorter periods.
“A number of indicators are flashing red lights that a recession may be upon us,” Adams said. “More data is needed to suss out whether the economy has definitively reached a turning point, but after two consecutive months of falling consumer spending, the real GDP growth seems more likely than not to turn negative in early 2023."
Many experts now peg the next interest rate hike by the Federal Reserve, which will be announced next week, at 0.25% instead of 0.5%. What’s more, some believe the central bank could hold rates steady at its second meeting in March and may actually start reducing interest rates later this year to combat cooling demand.
On Friday, the University of Michigan’s consumer sentiment survey showed a rebound in consumer confidence, from 59.7 in December to 64.9 this month, though the index is still 3.4% lower than the same point last year. The index is also off its lowest level since 2010, not including 2020 when Covid-19 first struck the United States.
“Slowing inflation provides some much-needed upward momentum for consumer sentiment," Joanne Hsu, the survey’s chief economist, said in a statement, warning that the debt ceiling political debate could threaten consumer sentiment. “Past debt ceiling crises in 2011 and 2013 prompted steep declines in consumer confidence.”
The survey noted about one-third of consumers pointing out the dramatic increase in borrowing costs as the Fed’s interest rate hikes have trickled through the lending world, and about the same percentage of surveyed consumers expect home prices to fall in 2023, the largest portion of consumers saying so since the January 2007 survey.
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