Economic Update Summer 2022
First-quarter growth declined at a 1.6% annualized rate, and an estimate from the Atlanta Fed, GDPNow tracker, project -1.9% GDP growth rate in the second quarter. Two consecutive quarters of negative real growth is a technical recession by one definition. According to the National Bureau of Economic Research (NBER), a recession refers to a significant decline in economic activity, lasting more than a few months, normally visible in real gross domestic product, real income, employment, industrial production, and wholesale-retail sales. The U.S. economy is not there yet but slipping that way.
Nominal growth in the economy is still positive a sign that parts of the economy is growing while other parts are slowing. The latest ISM Services and Manufacturing Indexes are still in expansion territory. Coincident Indicators point to slower growth not recession yet. Lastly, Leading Economic Indicators (LEI) fell again in May, due to sharply lower stock prices, a slowdown in housing construction, and recession level consumer expectations. The index is still in expansion readings, but the current reading suggests weaker economic activity is in the near term with tighter monetary policy acting as a strong headwind to economic growth. The Global Purchasing Manager indices, show that the Fed’s tightening actions are having an immediate impact on demand in the U.S. economy. Key economic indicators are not yet at recessionary levels. Instead, they point towards a slowdown, and considerable risk of recession.
The economy is in a period of stagflation. Stagflation is when the economy experiences higher inflation (3-4%) and lower economic growth. The combination often leads to higher unemployment which results in households cutting back on spending. The good news that businesses, and households are in excellent financial shape, and unemployment likely not to hit levels associated with past recessions. Consumer financial obligations ratio finished 2021 at 14.0%. That is the share of consumers’ after-tax incomes that they need to use on debt obligations (like mortgage payments and car loans) as well as recurring payments such as property taxes, homeowners’ insurance, and car lease payments. Since 1980 the ratio was never lower than 14.7%. Moreover, as of year-end, household net worth was more than eight times annual after-tax income, the highest ratio on record (checkable deposits and currency of $4.1 trillion).
Unemployment is at cyclical lows of 3.6% says economy is not in a recession. Unemployment would be 2.2% higher at 5-6% range if economy were in a recession. The 4-Week Moving Average of Initial Claims, the best coincident indicator of a recession, shows that economy is not in one. The Initial Claims 4-week Moving average must hit 400,000 to signal a recession. Presently, it is 231,750. The unemployment rate is more than likely to rise over next twelve months above 4%. Job gains, low unemployment claims have seen their best days. Minor layoffs by firms are occurring and hiring is slowing. If hiring drops off and layoffs begin in meaningful scale, then more parts of a strict definition of a recession would be met. In the past, when the U.S economy has had two consecutive quarters of declining GDP, it has had a recession since WWII era. Past recessions lasted 10 months on average since 1948 according to CFRA.
Inflation remains stubbornly high at levels not seen since the 1980’s, However, many inflation indicators and contributors are gradually losing steam. Money Supply has fallen precipitously since Fed began hiking. Commodities, materials, oil, and Personal Consumption Expenditures are rolling over. The Federal Reserve’s preferred measure, Core personal consumption expenditures (PCE) prices rose 4.7% year-over-year, below previous level. Core PCE inflation which excludes energy and food inflation has slightly moderated. The Consumer Price Index, which measures a broad range of goods and services, rose 8.6% in May, the fastest advance in more than 40 years. Markets are anticipating that future prints may show peak inflation this summer. Higher interest rates, layoffs, lower energy prices (gasoline peaked), lower commodity prices, stronger U.S. dollar (20-year high), should feed into lower future prints. Wholesale prices which feed into retail inflation appears to have peaked at record levels. The latest report released by BEA shows consumption rising but inflation and higher rates are beginning to slow down consumer spending. The Fed will be successful in destroying demand to lower “goods” prices.
In June, the Fed raised its key rate, the Federal Funds Rate, by 0.75 basis points. The biggest hike since 1994 comes with inflation running at its fastest pace decades. The policy tightening is happening with economic growth already slowing while inflation hovers at cyclical highs, a condition known as stagflation. Other research shows that Inflation at current levels with a fast-tightening policy has consistently caused a downturn in the economy. Monetary policy’s takes 9-18 months on average to stall aggregate consumer demand, create tight financial conditions, and higher unemployment.
Recent inflation indicators show early signs that inflation is slowing. A couple more prints should confirm its trend. Inflation expectations are coming down which means the Fed might not need to hike as much as planned. The FOMC planned hikes combined with its quantitative tightening program is creating tighter financial conditions than necessary to quell inflation.
Price movements in the Yield curve and credit markets are signaling greater risks of recession. The yield curve inverted in some parts. The 2’s and 10’s part is signaling that the U.S. economy is slipping in a recession. When the 3’s 10’s, the best indicator of a recession, inverts it will be a closed case and a late call. Whereas the credit market spreads have widened warning of slower economic growth and credit risks.