Global Equity Markets, 23 January 2023

US equities struggle after a fresh start to 2023

Signs of the US recession are becoming more evident as retail and industrial data disappoint. The US retail sales contracted for the second consecutive month by 1.0% and 1.1% m/m in November and December, respectively. As consumer spending is usually affected near the beginning of economic slowdowns, this recent data may be potentially signaling an upcoming recession in the US. Furthermore, industrial production contracted for the third month in a row to reach -0.7% m/m in December. These developments have led to a significant shift in analyst forecasts and general investor sentiment. For instance, JPMorgan has downgraded the US economic outlook and now expects a mild recession in 2023 under the baseline scenario instead of a slow growth.

Surge in consumer credit creates worries on potential defaults. During 2022, strong spending was supported by pent up savings from the pandemic period. As these savings have exhausted, consumers have now turned to borrowing to finance their spending. Importantly, high consumer debt can be especially problematic during recessionary periods with high interest rates, as default likelihood tends to be the highest under such a scenario. The materiality of this issue is supported further by the fact that the US banks have increased their provisions for credit defaults in 4Q22.

Is this all part of Fed’s plan? The reason why markets are reacting relatively smoothly to such disappointing data releases is that the moderate economic slowdown is already widely anticipated. Therefore, a mild deterioration in supply and demand conditions in coming months will not serve as radical catalyst for capital markets. For further sharp declines, inflation in the US will need to prove stickier and push the Fed to increase duration and/or magnitude of rate hikes. Alternatively, significant worsening of consumer demand, labor market, or production conditions can also serve as negative market catalysts.
This week’s earnings from some of the largest US companies as well as the US GDP and inflation (PCE) data will provide further insight into the abovementioned view on likelihood and possible depth of the US recession.