Economy Spring 2022

The U.S economy remains in an expansion. Real gross domestic product (GDP) increased at an annual rate of 6.9% in the fourth quarter of 2021.The GDPNow model estimate for real GDP growth in the first quarter of 2022 is 1.1%. For the remaining quarters GDP is projected to grow on average 3%. Next year, TD Economics forecast U.S. economic growth of 2.2%.

The U.S. economy is going through a transition period this year. I am more in the stagflation camp over the next twelve months and not recession. Stagflations looks like 1.1% economic growth and y-o-y inflation of 8.5%! I see inflation peaking by the summer and dropping by year-end. It is difficult for U.S. economy to fall into recession given consumer strength and strong employment numbers.

Recent ISM indexes both Service and Manufacturing show expansion readings, despite ongoing struggles with supply chains. Sustained employment growth helping to alleviate labor shortages. Moreover, the March payrolls gain showed expansion numbers and the employment report improving labor force participation rate. The Labor Department reported that Continuing claims dropped to the lowest level since December 1969. Weekly jobless claims fell to lowest level since 1963 in March. Unemployment fell to 3.6% rate the lowest in over a decade. I am watching initial Jobless claims which is a leading indicator. Initial Jobless claims bottom out 34 weeks on average before the beginning of a recession. The economy must see initial jobless claims get worse for a quarter before I become more concerned about a recession. Also, the unemployment rate is a leading indicator that tends to bottom four months before the beginning of a recession. Consumer spending, derived from employment, would sink lower with higher unemployment. Sixty five percent of the U.S. economy is consumer driven. It is the backbone of U.S economic growth.

The consumer is in the best financial shape in over a decade. Household finances are healthy. Disposable personal income continues to grow at a strong pace of 5.7% rate, but inflation is eating away at consumer purchasing power and creating conditions for demand destruction. Presently, consumers are earning more and saving more. Savings rate of 5.9% and wage growth supports consumer spending in 2022 which supports corporate earnings estimates. It would be constructive for spending to see inflation peak and fall into year-end.

Inflation measured by the Consumer Price Index (CPI), a broad index, is jumping in all categories Goods, Services, Energy, Shelter, and Food. The CPI for March rose 8.5% – the highest since 1981. The CPI may peak this quarter and decline to 5.2% by year-end according to TD Economics. One Year Treasury Inflation Protected Notes (TIPs) breakeven yield is 2.61%. TIPs market saying Fed’s restrictive money policy will lower inflation by 2023. I am watching monthly change in CPI. If month-to-month inflation begins to decline to 0.3% monthly rate, then CPI is coming off boil. Tight labor conditions will keep inflation elevated.

The Federal Reserve (Fed) finally admits its way behind the inflation. To reduce inflation from current levels requires hurting demand created by removing excess cheap money from economy. Inflation is not just wage inflation, supply shortages, rents, and higher oil supply, its money supply too. There is too much money injected into the system creating inflation in most areas of the economy such as housing. The Federal reserve is now on a fast track for tightening financial conditions. Expect the next two hikes of fifty basis points each, and additional ones at each meeting until FFR reaches 2.75% in 2023. In addition, The Fed plans to shrink its massive balance sheet which further tightens financial conditions. By the end of 2023, the Fed plans to reduce its Balance sheet by $1 trillion dollars which equates to an additional 3.5% increase in tightening – that’s restrictive monetary policy. Piper Sandler research based on 61 years of data, shows eight recessions. All of them associated with Fed tightening in the vicinity of or above neutral. Only one clear exception to the rule (1994). Front ended rate hikes may undermine corporate earnings in fourth quarter as the effects of higher front ended rate hikes begin to slow economic growth sooner than later. On a constructive note, the 2-Year Treasury Note yield peaked and is falling at this time which implies rapid and open-ended rate hikes might not be the case.

The risk of a recession is higher in 2023. However, it is not a fait accompli. There are other macro-economic variables to account for to say outright the U.S economy is heading towards a recession. For example, Credit market indicators, the 3 months-to-10 years Treasury yield curve, ISM Indexes, Continuing claims, and Leading-to-Coincident Indicator all show expansion readings for now.