"Q1 2023 - The Economy Throws a 'Smoke Screen'"

  • By: Joseph R. Tranchini, CFA, CFP®
  • May 2023








A smoke screen. That is what the U.S. Economy so graciously provided to us in Q1 2023. In fact, if you were tasked with creating a set of economic data points that would achieve the goal of creating an illusion of rapidly slowing growth (a smoke screen) then it would be rather difficult to do a better job than what the Economy organically generated in Q1. Looking at our top-line GDP growth figure of 1.1% in Q1 and comparing that to the previous two quarters’ growth rates of 2.6% and 3.2% one might come to the conclusion that the U.S. Economy is in the midst of a large slowdown; however, that is far from the underlying reality, and the outlook may not necessarily be as ‘smokey’ as one might expect.

Getting into the numbers, it seems rather strange and counterintuitive that the U.S. Economy could be slowing down over the past 3 quarters when the largest, and third largest, components of GDP have accelerated over those 3 quarters (Consumer Spending & Government Spending). Keep in mind that the U.S. Trade Deficit also improved over this period of time as well, making the slowdown all the more puzzling. The culprit for this ‘smoke screen’ slowdown we have seen over the past few quarters is one that usually finds itself at the center of economic confusion (a repeat offender if you will) … Private Inventories.

Private Inventories are a notoriously common culprit for providing a ‘smoke screen’ effect over economic data due to the way in which it is measured. Essentially, the data point measures the change in the change of Inventory Levels (Ex: Adding 5 after adding 10 means a -50% decrease, even though overall levels were raised). And no, business inventories did not plummet as businesses decided a ‘storm’ was coming and froze purchasing across the whole economy; rather, Private Inventories have been steadily augmented since the start of 2021 and therefore were probably at a sufficient to meet demand, but not so high as to burden companies with undue costs. This ‘goldilocks’ level of inventories is much more likely to be an explanation for the Private Inventories effect in Q1, and not a structural degradation in business expectations.

Taking a step back from the Inventory data, let us look forward to what may be to come throughout the 2nd half of 2023, and into 2024. It is the consensus expectation that the Federal Reserve is done hiking rates, and will likely pivot to a more normal Monetary Policy stance by way of Rate Cuts before the end of 2023. After a long time of hearing about how interest rates are going higher and higher it may seem odd to start thinking about how that rhetoric is expected to shift in the opposite direction before the year is over, but that is precisely where we are. Lower rates have traditionally been a positive driver of economic growth and market performance as well.

Additionally, it is the expectation that the Labor Market will remain historically tight even if a gentle cooling-off were to occur. This would posit that Wage Growth may very well continue to be a factor in Consumers being able to steadily increase incomes to further combat the effects of Inflation, which has significantly waned over the past quarter. From the Consumer’s perspective, this backdrop may provide for a future that holds a unique combination of gainful employment, wage growth, and normalized prices across major spending categories.

It is my own belief, as well as the belief of many others, that a constellation of lower interest rates, a wealthier consumer, and waning inflationary pressures could provide a very beneficial path forward for the U.S. Economy and investment markets alike. There are bound to be bumps, bruises, and smoke screens along the way, but with the benefit of extremely solid footing and a bright outlook, we can successfully look through the ‘smoke screens’ and into an exciting economic future.


[See Below for Disclosures & Annotations]


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

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  1. FactSet. “Economics – Country/Region – United States”. May 4, 2023.
  2. Bureau of Economic Analysis. “Gross Domestic Product, 1st Quarter and Year 2023 (Advance Estimate)”. May 4, 2023.
  3. Bureau of Economic Analysis. “Labor Force Statistics from the Current Population Survey”. May 4, 2023.
  4. Bureau of Economic Analysis. “Personal Income”. May 4, 2023.
  5. FRED. “5-Year Breakeven Inflation Rate”. May 4, 2023.
  6. FRED. “10-Year Breakeven Inflation Rate”. May 4, 2023.