Six Financial Surprises So Far in 2023

As often happens, 2023 has been filled with economic and financial surprises. Commodity prices have been unexpectedly weak for a couple of primary reasons. Economic growth in China lagged, which I’ll discuss shortly, reducing demand for commodities.

Also, the war in Ukraine didn’t disrupt supplies as much as expected. Governments around the world and major players in the commodity markets quickly adapted by creating new supply chains. As a result, 2022’s surge in commodity prices retreated for most of 2023. China’s growth was expected to surge after it ended the zero-Covid policies in early 2023. Its economy had a brief pop in the spring, but it faded. Most recently, the data from China have been negative.

The pre-pandemic boom years saddled China with significant debt and imbalances that restrain growth. Also, the government has been more interested in restructuring the economy and restraining the private sector than encouraging growth. Of course, most of the world decided to become less dependent on China, causing trade and outside investments to decline. These and other factors make it unlikely the country will return to a high growth rate soon.

Another surprise was the strength of the U.S. economy after the Federal Reserve tightened monetary policy at perhaps its fastest rate ever in 2022. Both consumers and businesses had strong balance sheets because of all the pandemic stimulus and the lack of the debt binges and other excesses that usually precede a Fed tightening. The growth in 2020 and 2021 became sustainable through 2022 and 2023. Fed policies work with lags of 12 to 24 months.

There has been damage in the more leveraged and speculative sectors of the economy and the markets, as well as the traditional interest rate sensitive sectors, such as housing, commercial real estate and autos. We continue to see signs that slower growth is spreading, so it’s too soon to say the tightening won’t lead to a recession. Inflation also surprised many people. Market prices at the start of the year indicated investors believed that by summer inflation would reach the 2% target and the Fed would be cutting interest rates.

Of the factors that caused the high inflation of 2022, the supply chain issues and excess demand related to the pandemic largely have abated and the inflation caused by those factors rapidly declined. But strong demand continues for www.RetirementWatch.com September 2023 services and some goods. This demand, plus labor shortages, keeps compensation increases well above the average of the last few decades.

Inflation is likely to stay in the 3% to 4% range until these factors fade. Treasury bond interest rates haven’t increased as much as expected given the rapid increase in short-term interest rates the Fed strongly influences. The rates actually declined for much of the first part of 2023. That’s largely because the U.S. Treasury used some financial management strategies to reduce the number of bonds it had to issue.

Those strategies reached their limits, and the Treasury must issue more bonds the rest of the year. The recovery of U.S. stock indexes from their 2022 lows, despite declining earnings, is a major surprise so far. Stock prices were helped by strong corporate balance sheets, the relatively modest rise in intermediate- and longterm interest rates, and the hype about artificial intelligence. Also, the Fed temporarily increased market liquidity during the banking crisis last spring.

But perhaps the most important factor was investors were optimistic, believing inflation would fall without a recession and the Fed would be reducing interest rates by now. U.S. stock indexes are at very high valuations. For those valuations to be justified, the Fed has to reduce interest rates in 2024 at the rapid rate priced into the markets, and earnings have to increase faster than analysts currently expect.