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[...]consumers are now adjusting their spending habits in response to rising prices, i.e., they've started bargainhunting for cheaper products and are cutting back on services such as restaurants and entertainment or putting off larger planned purchases. [...]Wells Fargo have reduced their residential forecast to a 3% decline in the second quarter of 2022, citing a recent pullback in existing home sales and higher interest rates. Since raising the federal funds rate makes it more expensive to borrow and lowers the supply of available money, these changes are an indication of the Fed's policy to keep inflation under control. [...]Dr. Ray Perryman of the Perryman Group believes the Federal Reserve is well underway with their tightening measures, seeking to find a balance between moderating inflation and sustaining growth.
PARTICIPANTS I Conf. Board = Conference Board, New York, New York; Fannie Mae = Fannie Mae, Washington, D.C.; GSU - EFC = Georgia State University, Economic Forecasting Center, Atlanta, Georgia; Moody's Economy = Moody's Economy.com, Westchester, Pennsylvania; Mortgage = Mortgage Bankers Association, Washington, D.C.; NAM = National Association of Manufacturers, Washington, D.C.; Perryman Gp = The Perryman Group, Waco, Texas; Royal Bank of Canada, Toronto, Ontario, Canada; S&P = Standard & Poor's, New York, New York; US Chamber = U.S. Chamber of Commerce, Washington, D.C.; Wells Fargo = Wells Fargo Bank, San Francisco, California.
Expectations for the U. S. economy in the second half of 2022 suggest modest growth well into the first half of 2023. Consensus thus expects the nation's GDP growth rate to remain in the neighborhood of 1.65%. The consensus contains differing viewpoints, however. Dr. Ray Perryman of the Perryman Group expects the economy to face significant headwinds, with supply chain woes exacerbated by slowdowns in Chinese production and the Ukraine war weighing heavily on the oil and gas and grain markets. Wells Fargo, on the other hand, expects the economy to maintain a positive trajectory over the next two years with real GDP growth in the vicinity of 2.4% for 2022 as a whole, but to cool to 2.0% in 2023.
Recent increases in the price of crude ($121 per barrel as of this writing), the low unemployment rate (3.6%), expanded money supply during the pandemic, together with supply chain challenges, have raised inflation to a 40-year high (8.6% in May) making goods and services more expensive. At the same time, decreases in the pandemic assistance payments and a resurgence of the Omicron variant are keeping consumers cautious in terms of their spending. All of these factors can be seen as creating an environment of 'modest economic growth.
CONSUMER SPENDING STRONGER THAN EXPECTED & SET TO CONTINUE
Continuous improvement in the employment rate and increases in consumers' personal disposable income have positively affected consumption and subsequently have driven growth in the economy. However, Americans' wealth has taken a hit via stock market declines, despite continued gains in home values. Volatility in the stock market contribute to a reluctance in spending through the 'wealth effect'. Correspondingly, light vehicle sales are forecast to increase by more than 4% during the second half of 2022 but then decline to less than 1% well into the second quarter of 2023. This is an indication of hesitancy and caution by consumers, suggesting that economic growth is set to moderate significantly with a slowdown being amplified by inflation pressures.
The ratio of Personal Consumption Expenditures to Personal Disposable Income is predicted to remain at around 91% during the consensus period. The increase in Personal Disposable Income is expected to remain around its current level of 3.02% whereas the increase in Personal Consumption Expenditures is likely to remain stable at 3.91% from third quarter of 2022 to the second quarter of 2023. The ratio tilts toward expenditures which suggests that consumers have leveled their debt burden and increased savings during the pandemic. However, with increases in Personal Disposable Income being at only at the 1% level for each quarter, combined with consumers' willingness to spend at higher rates, indicates a potential surge in personal debt through credit card spending.
As such, Wells Fargo has noted that personal consumption was stronger than anticipated in Q1, which encouraged the bank to slightly boost their real Personal Consumption Expenditure (PCE) forecast for the year. Nevertheless, they expect growth in consumer spending to slow with growth in real PCE not to exceed 2% at any point in the forecast period. Lastly, approximately 87% of GDP should be allocated to Personal Consumption Expenditures in the second half of 2022, and about 88% during the first half of 2023. This again indicates that consumers will likely utilize credit card debt more so than before. As is always the case, consumption continues to be the largest component of GDP growth.
FIRMS: SHORTAGE OF WORKERS PUSHES WAGES HIGHER, PRIVATE HOUSING STARTS FORESHADOW ECONOMIC SLOWDOWN
The unemployment rate (3.6%) will change minimally from its projected 3.12% in the third quarter of 2022 to 3.20% in the second quarter of 2023. Lingering within this range will move the economy closer to full employment, giving employees leverage to negotiate higher wages after several years of stagnation.
With a shrinking pool of available workers, businesses are likely to keep lifting wages in order to fill a record number of job openings. Higher wages will no doubt help offset higher costs of living. There is an increasing likelihood that businesses will pass on rising costs, further adding to inflation. Wells Fargo anticipates the unemployment rate to fall to 3.3% in Q42022. A slower pace of job growth and increased labor force participation is likely to raise the unemployment rate slightly in the second half of 2023. Consensus expects the unemployment rate to average 3.5% by the end of 2023.
Light vehicle sales have exceeded 15 million in 2022 and are expected to reach 16.31 million in the second quarter of 2023. This is growth in excess of 6%, suggesting that consumers will continue to purchase big-ticket items well into Q4-2022 and then moderate during the first half of 2023.
Chained Price Index growth is expected to be 2.25%, vs Consumer Price Index growth of 2.24% for the consensus period. (The chained price index is a measure of the price of consumer goods and services based on consumers' behavior of substituting products with less expensive ones in an inflationary environment.) Thus, the percent change suggested by consensus is a clear sign of a shift in consumer behavior toward higher price sensitivity and substituting more expensive goods and services with less expensive choices. Accordingly, consumers are now adjusting their spending habits in response to rising prices, i.e., they've started bargainhunting for cheaper products and are cutting back on services such as restaurants and entertainment or putting off larger planned purchases. In response, firms are expected to become more innovative and competitive, focusing on delivering additional value to consumers.
Industrial Capacity Utilization is expected to stay at 79% well into the end of 2022 and slightly increase in the first quarter of 2023. This provides mixed news for the economy. On the one hand, business investment has picked up and firms will continue to look for innovative methodologies to push down the cost of production and improve competitive pricing for domestic and foreign consumers. On the other hand, rising oil prices, supply chain challenges, labor shortages, and higher wages might cause bankruptcies for many small companies.
Non-Residential Fixed Investment is expected to grow by 2.42% - greater than the GDP growth rate from the third quarter of 2022 to the second quarter of 2023. This represents continued improvement in productivity and competitiveness of the U. S. economy. Private Housing Starts are expected to decrease from 1.69 million units to 1.61 million units between the third quarter of 2022 and the second quarter of 2023 - a decent 4.74% decline. This would represent a significant negative impact to employment and economic growth. Accordingly, Wells Fargo have reduced their residential forecast to a 3% decline in the second quarter of 2022, citing a recent pullback in existing home sales and higher interest rates. Although some slowing seems inevitable, buyer demand is likely to remain resilient thanks to an incoming wave of young millennial buyers. Overall, the housing market losing steam as interest rates climb higher may be a preview of what is to come with the rest of the economy.
INTEREST, CREDIT, AND THE FED: TIGHTENING ALREADY UNDER WAY
According to the consensus, the triple "A" quality corporate bond rate (now at 4.20%) is expected to increase from 4.27% in the second quarter of 2023 to 4.60% in the third quarter of 2023, representing a 7.57% increase.
The consensus forecasts the Federal Funds Rate (the interest rate at which depository institutions lend balances to each other overnight) to increase from 1.76% in the third quarter of 2022 to 2.27% in the 4th quarter of 2022, and then to 2.97% in the second quarter of 2023. These are in line with Wells Fargo's expectations of a 50-bps hike in the June, July, and September FOMC meetings. Since raising the federal funds rate makes it more expensive to borrow and lowers the supply of available money, these changes are an indication of the Fed's policy to keep inflation under control. Accordingly, Dr. Ray Perryman of the Perryman Group believes the Federal Reserve is well underway with their tightening measures, seeking to find a balance between moderating inflation and sustaining growth.
CONCLUSION: ECONOMY IN TRANSITION FOLLOWING A PERIOD OF HISTORIC RECOVERY
To sum up, the consensus believes that employment is improving, and consumer spending and business investment have increased and will likely continue to do well. Wells Fargo expects business investment to expand to 6% in 2022 and then slow down slightly to 4.3% in 2023. Moreover, they believe the Fed will very likely raise the effective Federal Funds rate at a slightly more aggressive pace this year in order to dampen inflation. However, rising oil prices, supply chain issues, the impact of the Ukrainian war on oil and gas and grain prices might have a negative impact on the growth of the economy in 2022 and 2023. Further, the absence of fiscal and monetary stimulus would considerably moderate growth, a slowdown amplified by inflation pressures. Moreover, a slowdown in the world's other big economies and troubles with emerging markets may also have a bearing on the US GDP growth rate. Despite these many challenges, momentum in jobs, consumer spending, and other key sectors may sustain modest growth in the economy.
Secretary Yellen indicated in her latest remarks that this is a period of transition from one of historic recovery to one that can be marked by stable and steady growth where inflation is controlled without sacrificing the economics gains made.
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Copyright Journal of Business Forecasting Summer 2022