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The economy grew at a faster than forecast into the end of 2022 but there were signs of slowing underlying demand as the steepest interest rate hikes in decades threaten growth.

GDP increased at a 2.9% annualized rate in the final three months of 2022, after a 3.2% gain in the third quarter.  About half of the GDP increase reflected inventory growth, while government outlays had the largest gain since early 2021.  Personal consumption, the biggest part of the economy climbed at a below forecast 2.1% pace.

The mixed report suggests that the Federal Reserve still has a path to a soft landing with officials set to further downshift their rate increases next week and debate when to pause.  The Fed’s preferred price gauge rose at the slowest pace in two years.

On the other hand, weekly unemployment claims fell to the lowest level in nine months suggesting the economy is still very robust.

Inflation is around 6.5%, considerably above the 2% target rate.  Jobs growth is still strong.  The data is indicating some softening in prices and growth, but the easy lifting on prices has already been done.

Next week is a Fed meeting.  The markets have vacillated between another 50-bps increase or a downshift to 25 bps, settling on the latter.

Through numerous Fed speeches and policy statements, the Fed has consistently guided the markets to anticipate a peak rate of slightly more than 5.0% and keep it there for the remaining of 2023.

Despite this uniform and consistent message from Fed officials, the markets continually to refuse to fully price in this policy guidance.  Instead, traders expect the Fed to cut rates in the second half of the year, making large wagers that such will come to fruition.

This leaves the Fed with little latitude.  The Fed must convince the markets that they are ahead of inflationary expectations and implement a policy action consistent with this and therefore partially repair its credibility, which was damaged by its gross mischaracterization of inflation for almost all of 2021 and after that, too modest of an initial policy response.

Writing it differently, the Fed must reestablish itself as an inflation hawk given the possible negative ramifications of unrelenting inflation on the nation’s $31.5 trillion debt.  As noted several times, the debt service on the debt already doubled from last year’s level and at some juncture will begin to crowd out other expenditures.

Last night the foreign markets were up.  London was up 0.05%,  Paris down 0.14%  and Frankfurt up 0.01%.  China was up 0.65%, Japan up 0.07%  and Hang Seng up 0.54%.

Dow and NASDAQ futures are flat and down 0.50%, respectively on INTC’s warning. The 10-year is off 12/32 to yield 3.55%.

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Kent Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.