Real GDP growth ended 2022 with 2.9% growth in the fourth quarter. However, the quarter ended with data pointing to a clear weakening in growth. Notably, consumer spending declined in both November and December, forming a trend indicating that consumer spending could stagnate in the first half of 2023. Despite slight improvements in housing market dynamics in recent weeks, a continued slide in building permits indicates that residential investment will likely remain a significant drag on economic growth.
There have also been several positive developments recently that boost the odds that the U.S. economy could avoid a recession. For one, the labor market remains firm as the unemployment rate fell to 3.4% in January, a rate that has not been experienced since 1969. Furthermore, January’s jobs report was delivered with positive revisions to past data that raised the average level of employment over the past few periods and showed a stronger pace of hiring in the final months of 2022. Bearing all this in mind, market participants now expect smaller declines in employment this year than previously assumed.
The labor market is holding up while inflation appears to be receding at a pace a bit faster than anticipated. The Consumer Price Index declined in December for the first time since early 2020, and the annualized run rate over the previous three months averaged just 1.8%. Lower inflation is mainly attributable to falling energy and goods prices. Services price increases have yet to cool, but there are signs that wage growth, which is an underlying driver of prices in the labor-intensive service sector, is beginning to moderate. The Employment Cost Index rose 1.0% in the final quarter of 2022, a slower gain than expected and the third consecutive quarterly moderation. Wage growth is still running at a pace inconsistent with 2% inflation, however, long-term inflation. The recent cooling in wage pressures without a material downgrade in labor market conditions is an encouraging sign that tighter monetary policy is having the desired impact of cooling inflation without broadly damaging economic activity.
Another reason for cautious optimism is that the combination of easing inflation and solid income growth appears to be enhancing consumer purchasing power. Real disposable income growth has been flat or positive in every month since July. After declining steadily for most of 2022, the saving rate ticked up in November and December. The lagged effects of higher interest rates may lead real disposable personal income to backtrack around the middle of the year. But diminished price pressures and strong employment growth lessen the risk consumer spending halts completely.
Agricultural Economy
The U.S. agricultural economy posted new record highs for net farm income in each of the past two years. However, farmers will face challenges in 2023 in the form of higher operating costs, higher interest rates, a strong dollar, and potentially weaker domestic and export demand for agricultural products. Other potential variables such as the course of the ongoing drought and increasing political tensions with our largest agricultural export market, China, will also factor into the health of the agricultural economy.
The National Weather Service’s Climate Prediction Center is currently expecting drought conditions to improve in the Midwest, the outlook for the West and the South is less favorable. Our evolving political relationship with China will continue to have a meaningful impact on the agricultural economy given that China has made it clear that it would like to minimize its dependence on imports of U.S. farm products. China’s recent decision to allow several major international traders to ship corn from Brazil, the largest competitor of the U.S. for grain and oilseed exports. Offsetting China’s desire to decrease its reliance on U.S. agricultural products is that global grain and oilseed supplies are exceedingly tight. The combined global ending stocks of corn, wheat, and soybeans are forecast to decline for the fifth straight year in 2023. For the 2023 harvest, the futures market is currently offering strong prices, but when accounting for increases in production costs, profitability is expected to be near breakeven.
While still being at above average levels, wholesale fertilizer prices and natural gas prices have declined since last fall. Although many had expected both prices to rise in late 2022 and early 2023 due to lower gas imports from Russia, European countries have built natural gas reserves through conservation efforts, the warmest winter there in a decade, and the delivery of record U.S. natural gas exports.
Fertilizer production is dependent on natural gas as a feedstock, an energy source, or both depending on product type. As a result, a decline in natural gas prices causes the cost of fertilizer production to decrease, most notably for nitrogen. From peak-to-trough over the past several months, U.S. natural gas prices have declined by 67%, compared to price drops of 24% for anhydrous ammonia, 16% for phosphate and 18% for potash. If this recent decline in natural gas prices lasts through spring, fertilizer prices would be expected to remain lower than recent highs.
Despite historically strong milk prices in 2022 the domestic dairy cow herd has not grown a meaningful amount as herd growth has been impaired due to several factors including high costs for feed, construction materials, and replacement heifers, as well as tight labor availability, and the ongoing drought in the West. Domestic demand for U.S. dairy products remains firm, however demand is expected to cool in 2023 due to inflationary pressures on consumer spending. Softening demand is expected to result in lower milk prices, but wholesale and retail dairy product prices have remained mostly resilient so far. Ongoing structural changes within the dairy processing industry will likely persist in 2023 with the continual expansion of cheese processing capacity expected to divert milk away from butter churns, providing ample cheese supplies while keeping butter inventories tight. This trend would suggest that Class IV milk prices will likely maintain a premium to Class III milk in 2023.
Most U.S. animal protein industry segments have posted very strong financial performance over the past three years. However, the levels of profitability experienced in recent years will likely come to an end in 2023. On the demand side, consumers are making efforts to reduce spending in response to higher inflation and higher interest rates. Retail grocery sales of animal protein products continue to rise, but not as fast as inflation, meaning that sales volumes have begun to decline in recent months. After reaching a projected record high of more than 226 pounds per capita in 2022, U.S. meat and poultry consumption is expected to flat or slightly lower 2023, with marginal gains in chicken and pork offsetting a decline in beef.
Following eight years of growth, red meat production is projected to decline by up 2 billion pounds in 2023 because of shrinking cattle supplies. The decline reflects an estimated 5% annual reduction in total beef cow inventory and comes at a time when beef still has strong consumer demand. As a result, prices may remain historically strong, in both live cattle and beef markets. While pork production is expected to have a moderate rebound in 2023, the breeding herd below its peak in 2020. The domestic pork supply has benefitted from a reduction in exports and an increase in imports.
To view the article in the online 2023 Spring Partners Magazine, click here.
