These three big unknowns will drive markets in 2023

By Nicole Goodkind, CNN

We’re in the salad days of the New Year — that period where many feel refreshed and motivated and perhaps even optimistic about the year to come. There’s a certain clarity that comes during this time in January.

That said, the big question weighing on everyone’s mind is whether or not the United States will enter a recession this year. And there are three big “ifs” that will determine the health of the economy: The strength of the labor market, the American consumer and the Federal Reserve.

Will the labor market cool off?

Jobs has been the word of the week as investors eye a slew of data highlighting a strong labor market that is confoundingly resistant to the Fed’s attempts to cool the economy.

The US labor market is historically tight, with the unemployment rate, as of November, at just 3.7% and about 1.7 available jobs for every job seeker. If job numbers come in as expected on Friday, 2022 will be the second-best year on record for job growth.

This is all happening as the Fed tries to actively cool the labor market. Policymakers fear that persistent wage growth in a tight labor market will keep already sky-high inflation levels elevated.

For the Fed to reach its desired target of 2% inflation, jobs will have to take a hit, with unemployment rising to about 4.6% this year, according to the central bank’s projections released in December. The central bank will likely continue to put pressure on the economy by instituting painful rate hikes until we get there.

In an interview with the Financial Times this week, Gita Gopinath, second in command at the International Monetary Fund, urged the Fed to continue with rate increases this year, citing the labor market’s resilience.

So will wages moderate this year? Analysts at Goldman Sachs predict that they will. They believe that unemployment will grow and wage growth will slow from above 5% in 2022 to about 4% by the end of this year.

“This would still be a bit too hot, but any sizeable drop would provide Fed officials with a proof of concept for the idea that gradual labor market rebalancing can dampen wage and eventually price pressures without a recession,” they write.

If 2022 taught investors anything, it’s that you can’t beat the Fed. So expect more good-is-bad economic news, since a strong monthly jobs report will likely continue to correlate to a weak market.

Will Americans continue to spend?

American consumers carried the weight of the economy on their backs last year. Even as interest rates rose and growth weakened, they kept on shopping.

Bank of America CEO Brian Moynihan told CNN around the holidays that the continued strength of the US consumer is nearly single-handedly staving off recession.

But weaker-than-expected retail sales in November pummeled market sentiment last month and raised the odds that the Fed’s punishing interest rate hikes would push the economy into recession.

US retail sales fell 0.6% in November, the weakest performance in nearly a year. Weak sales are likely to continue, say analysts, and if they do, retailers’ earnings will suffer.

Disposable income fell from the spring of 2021 through the summer of 2022 as inflation outran wage growth and pandemic savings dried up. While American bank accounts are still fairly robust, consumers are borrowing more. In the third quarter of 2022, credit card balances jumped 15% year over year. That’s the largest annual jump since the New York Fed began tracking the data in 2004.

Will the Fed pivot?

This is the main question on every investor’s mind — and the answer will not only help determine what happens to markets this year, but also whether the economy will fall into recession.

In the minutes from the December Fed meeting, central bank officials spelled it out for interested parties: No policy makers anticipated that rate cuts would be appropriate in 2023. The minutes warned that “an unwarranted easing in financial conditions … would complicate the Committee’s effort to restore price stability.”

And while officials welcomed softer inflation reports in recent months, they stressed that “substantially more evidence of progress” was required and said that inflation was still “unacceptably high.”

So while rate cuts may be off the table this year, the Fed could opt for more modest increases, or even none at all as the year progresses. That would be welcome relief to investors after four hikes of three-quarters of a point last year.

Mortgage rates continue to soar

Mortgage rates rose again last week, beginning 2023 twice as high as they were a year ago. The hike also reverses six straight weeks of falling rates.

The 30-year fixed-rate mortgage averaged 6.48% in the week ending January 5, up from 6.42% the week before, according to Freddie Mac. A year ago, the 30-year fixed rate was 3.22%.

Mortgage rates rose throughout most of 2022, spurred by the Federal Reserve’s unprecedented campaign of harsh interest rate hikes to tame soaring inflation. But mortgage rates dropped in November and December, following data that showed inflation may have finally reached its peak, reports my colleague Anna Bahney.

The current market is driving away would-be buyers, partially because there’s little inventory as Americans are uninterested in selling and parting ways with their ultra-low mortgage rates.

Still, this week’s drive upwards could be a fluke and as inflation begins to ease, rates are expected to also drop.

“Mortgage application activity sunk to a quarter-century low this week as high mortgage rates continue to weaken the housing market,” said Sam Khater, Freddie Mac’s chief economist. “While mortgage market activity has significantly shrunk over the last year, inflationary pressures are easing and should lead to lower mortgage rates in 2023.”

Bed Bath & bankruptcy

The future looks grim for Bed Bath & Beyond. The long-suffering retailer issued an ominous message on Thursday, warning about possible bankruptcy.

There is “substantial doubt about the company’s ability to continue” because of its worsening financial situation, the home goods chain said in a regulatory filing.

The company said that it was still looking into alternatives, like restructuring its debt, seeking additional cash and selling assets.

But the Wall Street Journal reported that Bed Bath & Beyond is preparing to file for bankruptcy within weeks, citing sources familiar with the matter. Bed Bath & Beyond did not immediately respond to a request for comment from CNN.

Bed Bath & Beyond’s (BBY) stock plunged nearly 30% Thursday. It dipped below $2 a share, an all-time low.

“Bed Bath & Beyond is too far gone to be saved in its present form,” Neil Saunders, an analyst at GlobalData Retail, said in a note to clients Thursday. “All of this points to bankruptcy as being the most likely outcome.”

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