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Quarterly CIO Commentary – Q4 2023

Slower growth ahead

Brian Henderson
This report was prepared by Brian Henderson Chief Investment Officer

This year may end with not quite a whimper—but not a roar.

We went into 2023 with many economists forecasting the risk of recession or at least slower economic growth. After all, the U.S. was—and still is—amid one of the most aggressive rate-hiking cycles we’ve ever seen, as the Federal Reserve works to purposely slow the economy to bring down inflation.

Instead, the first quarter was astoundingly strong: gross domestic product (GDP) grew by 2%, slightly above the trend level, driven by the resilient job market and, consequently, sound consumer spending. Almost half of all the jobs created this year through September were in the first quarter alone.

Q4 may be the slowest quarter of 2023

Since then, as expected, job growth has been declining each quarter as the Fed continued to raise rates. Even so, economic growth has accelerated all year, with each subsequent quarter getting stronger.

But the fourth quarter likely will be a temporary pause in that upward momentum.

Even if there isn’t another rate hike, job growth will be the slowest we’ve seen all year, although still positive, as the previous hikes' lagging effects permeate the economy. We’re already seeing reduced worker demand, as the number of job openings has been declining, though it is still a hot labor market.

Additionally, factors outside the Fed’s control will likely stir the pot, temporarily dampening economic growth for the remainder of the year. They are:

  • The United Auto Workers (UAW) strike: Since starting Sept. 15, the longer the strike, the lower it will push manufacturing production levels. Still, there likely won’t be a huge impact on 4Q GDP—maybe -0.1% or -0.2%.
  • Restarting student loan payments: After being on pause during the pandemic, student loan payments resumed on Oct. 1. One in five U.S. adults have student loan debt, with the average debt for a bachelor’s degree totaling $28,400 and the average graduate school debt totaling $71,000 (not including much pricier law school and medical school debt). Having to resume payments on this debt means that these consumers will have less of their income to spend on other goods and services.
  • The federal government shutdown: Congress narrowly avoided a shutdown by Oct. 1 by signing a short-term funding bill. The move keeps the federal government open until Nov. 17. At this point, it could be at risk of a temporary shutdown again if Congress doesn’t pass a budget. If a shutdown does happen, it would reduce government spending in the short term, thereby negatively impacting economic growth.

Of those factors, the impact of the first and third will be short-term and economic growth should bounce back quickly. However, the impact of resuming student loan payments will be harder for the economy to recover from.

Energy prices could raise inflation again

Part of the problem is that consumers now have student loans to repay again and already deal with higher household costs due to inflation. Although the Consumer Price Index (CPI) has fallen substantially from where we were a year ago, the biggest reason for the drop was lower energy prices, which have been rising again most recently. That means that consumers, especially those with lower incomes, are having to spend more of their paychecks on gas, and it also means that overall inflation is rising again. Already, CPI rose 0.6% in August and 0.2% in July.

Moreover, core CPI, which excludes food and energy prices because of their volatility, was up 4.3% year-over-year in August. This is an issue for the Fed because it’s still above their 2% target, which means they may have to keep rates high at their current level or even hike again. The economy will continue to slow as rates stay at this high level—or especially if they go higher.

What’s ahead for investments?

Companies will be releasing their earnings reports in October and November, and they may be pretty positive, given how strong the economy was in the third quarter. That would be good for the stock market. However, as always, if the companies’ outlooks are more negative—for instance, if they forecast a dramatic down in consumer spending or include comments about less hiring ahead—that could negatively impact stocks.

The bond market, meanwhile, is in a pretty good spot. It’s predicting one more rate hike at the end of this year and only two rate cuts in 2024—an outlook that has raised current yields. However, I’m slightly concerned that we’ll see more credit quality downgrades and higher defaults on high-yield “junk” bonds.

A positive note

It’s easy to get caught up in the negatives—especially when slower growth might be ahead—but the economy also has some bright sides. For instance, the Inflation Reduction Act and the CHIPS and Science Act have been subsidizing manufacturing renewable energy equipment, providing incentives for manufacturing electric cars, and providing incentives for manufacturing semiconductors in the U.S. This government spending accelerates the U.S. economy, and we’ve already seen a boost in American manufacturing and construction jobs. Of course, this boost somewhat dampens the Fed’s efforts to reduce inflation by slowing the economy, so even this positive note has its costs.

Still, an increase in manufacturing is good for the future. While the outlook for the fourth quarter is slower growth, it’s important, as always, to maintain a longer-term view when it comes to the economy and investing.