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According to Dr. Ray Perryman of the Perryman Group, the solid job growth in recent months (August unemployment stood at 3.7%) suggests that recessionary fears are overblown, even considering the two-quarter decline in GDP (much of which is attributable to rising exports, which indicates progress on supply chain issues). According to Rajeev Dhawan of the Georgia State University, energy-price-hike-inducedinflation has cratered domestic consumer confidence, signaling less spending in the coming months. [...]C-suite confidence is low, translating into weak capital expenditures. [...]Wells Fargo have considerably reduced their residential forecast as higher mortgage rates (U. S. mortgage rates touched their highest level in nearly 14 years in early September causing another blow to the rapidly cooling housing market) and rising recession risks have weighed on housing activity.
Expectations for the U. S. economy in the fourth quarter of 2022 point to slim growth. Consensus anticipates the nation's GDP growth rate to remain at around 0.4% well into third quarter of 2023. According to Dr. Ray Perryman of the Perryman Group, the solid job growth in recent months (August unemployment stood at 3.7%) suggests that recessionary fears are overblown, even considering the two-quarter decline in GDP (much of which is attributable to rising exports, which indicates progress on supply chain issues). Similarly, Wells Fargo believes that broad economic activity is not consistent with a downturn yet due to the strength of the labor market as employers hired at a robust pace in the second quarter of 2022, adding 1.2 million jobs with over half a million in July alone. It's tough to square these robust hiring figures with an economy in recession.
Nevertheless, in his economic forecast for the nation, released on Aug. 31st, Rajeev Dhawan of Georgia State
University described the current economic condition as "bearflation" which he defines as "a combination of hot inflation, accompanied by sharp stock market declines at near full-employment, in the face of an energy crisis that is eroding consumer confidence, thereby making corporations hesitant to invest in capital expenditures - which will turn the current stall in income growth into an NBER (National Bureau of Economic Research) style recession as the Fed remains resolute with interest rate hikes."
While recent declines in the price of crude oil (about $86 a barrel in September) have eased the price of gas at the pump, there is still an expanded money supply available in the economy, with M2 at more than $21,700 billion in August. Given that, Perryman indicates that inflation and rising interest rates create some headwinds and employment expansion is likely to moderate in the coming months.
CONSUMERS: SPENDING DECREASES AS WEALTH EFFECT IS ERRODED
A strong job market and steady increases in consumers' personal disposable incomes should help raise consumption and improve economic growth. However, Americans' wealth has taken a hit via sharp stock market declines. Volatility in the stock market with the S&P 500 below 4000 contributes to a decrease in consumer spending as the wealth effect is eroded. Similarly, light vehicle sales forecasts during the Consensus period reveal that auto purchases are likely to increase by only 2.5% during the first half of 2023 and then increase to 4.86% well into the third quarter of 2023. This is an indication of both uncertainty and carefulness on the part of consumers in their bigticket item purchases, signifying that economic growth is likely to moderate, representing a slowdown intensified by persistent inflation pressures.
The ratio of Personal Consumption Expenditures to Personal Disposable Income is predicted to remain at around 92% during the Consensus period. This is heavy consumption, impacting household saving and pushing consumers to utilize their credit cards heavily. The increase in Personal Disposable Income is expected to remain around its current level of 3.14%, whereas the increase in Personal Consumption Expenditures goes up to 3.79% between the fourth quarter of 2022 and the third quarter of 2023. This implies consumers are reaching deep into
their pockets to find the means to continue spending in the face of the highest inflation in 40+ years. In other words, in order to keep spending, households are putting off saving. According to Rajeev Dhawan of the Georgia State University, energy-price-hike-inducedinflation has cratered domestic consumer confidence, signaling less spending in the coming months. As a result, C-suite confidence is low, translating into weak capital expenditures.
Chained Price Index growth is expected to be 2.30% vs. growth in the Consumer Price Index of 2.16% for the Consensus period. (The chained price index is a measure of price levels of consumer goods and services based on consumers' behavior of substituting products with less expensive ones in an inflationary environment). As such, consumers dre substituting more expensive goods and services with less expensive choices.
FIRMS: CAPITAL EXPENDITURE DROPS, GDP GROWTH SLUGGISH DESPITE PRODUCTIVITY
Consensus expects the unemployment rate (3.7% in September) to change somewhat from its projected 3.67% in the fourth quarter of 2022 to 4.27% in the third quarter of 2023. Similarly, Wells Fargo expects payroll growth to slow down and to turn negative in the spring when tight monetary policy tips the US economy into a recession. The expectation for unemployment late next year is around 5%. As such, they predict a mild recession by the beginning of 2023 as aggressive Fed tightening aims to tame persistently high inflation. Likewise, Perryman expects employment expansion to moderate in the coming months.
Industrial Capacity Utilization is expected to stay at 80% well into the third quarter of 2023. Non-Residential Fixed Investment is expected to grow by only about 1%- slightly greater than expected GDP growth from fourth quarter 2022 to third quarter 2023. This is sluggish growth considering the continued improvement in productivity and the competitiveness of the U. S. economy. Wells Fargo slightly lowered their growth estimates in response to lower oil price forecasts and declines in manufacturing projects. Dhawan believes the key driver of economic growth is capital expenditures, which he expects to decline because of plummeting confidence of CFOs (Chief Financial Officers) in the economy. Capital expenditure spending done today generates job growth six to nine months down the road. Hence, he expects capital expenditure spending to cool even further, which will impact job growth significantly in 2023. According to Consensus, light vehicle sales will be around 14.92 million in Q4 of 2022 and are expected to reach 15.64 million in the third quarter of 2023. This growth would represent a total growth of only 4.86%.
Private Housing Starts are expected to go down from 1.51 million units to 1.46 million units between the fourth quarter of 2022 to the third quarter of 2023-a decent 3.00% decline. This will significantly impact employment and economic growth. Dhawan's forecast on housing starts is even more severe, suggesting an average of 1.574 million starts in 2022 and down to 1.280 million in 2023. Accordingly, Wells Fargo have considerably reduced their residential forecast as higher mortgage rates (U. S. mortgage rates touched their highest level in nearly 14 years in early September causing another blow to the rapidly cooling housing market) and rising recession risks have weighed on housing activity. The rise in financing costs will weigh considerably on home buying. This slowdown in home buying will considerably impact job growth and add profoundly to recession risks.
INTEREST, CREDIT, AND THE FED: TIGHTENING TO CONTINUE INTO 2023
According to Consensus, the triple "A" quality corporate bond rate (4.46% in September) is expected to stay steady at around 4.45% in the fourth quarter of 2022 and 4.44% in the third quarter of 2023. On the other hand, Wells Fargo's 2022 year-end forecast for the 10-year Treasure yield is 3.15%, decreasing to 2.70% for 2023 year-end.
Consensus forecasts that the Federal Funds Rate (the interest rate at which depository institutions lend balances to each other overnight), is projected to increase from 3.38% in the fourth quarter of 2022 to 3.58% in A1 2023, and then stay steady at 3.60% in the third quarter of 2023. These are inline with the 75-bps hike we saw in September's FOMC meeting to bring the range to 3.75-4.00% at the end of 2022. Since raising the federal funds rate makes it more expensive to borrow and lowers the supply of money, these changes are an indication of the Fed's policy to keep inflation under control. Perryman believes that the Federal Reserve may ramp down its rate hikes in 2023, assuming that price pressures will ease modestly. Dhawan predicts
that the Fed will cut rates only when job growth has become decidedly negative.
CONCLUSION: EFFORTS TO TAME INFLATION FORESHADOW GLOBAL RECESSION
In summary, the US inflation rate declined less than expected to 8.3% in August. Federal Reserve Chairman Jerome Powell reiterated that the Fed is squarely focused on bringing down high inflation to prevent it from becoming entrenched as it did in the 1970s. Mortgage rates in the US topped 6% for the first time since 2008 before the September FOMC meeting. Moreover, the US yield curve is inverted causing implications for consumers and investors alike. An inverted yield curve means that short-term debt instruments carry higher yields than long-term instruments, suggesting greater economic risk in the near term. № is the most reliable leading indicator of an impending recession.
In other parts of the world, the European Central Bank raised interest rates by the largest amount since the early days of Europe's currency union, moving aggressively to combat record inflation. Rising borrowing costs will increase the risk of a slide into recession for the Eurozone Which is wrestling with surging energy costs and sagging confidence among households and businesses, driven by the war in neighboring Ukraine. Speaking of energy costs, the U. К. government plans to cap household energy prices over the next two years, a costly bailout aimed at staving off a deep recession and bringing down inflation, but one that could add to growing worries about the British government's financial health. Also, the Bank of England raised its key interest rate by half a percentage point in its longest cycle of increases since the late 1990s. Consequently, the World Bank believes the world may be edging toward a global recession as central banks across the world simultaneously hike interest rates to deal with persistent inflation.
Considering all these, a possible remedy could be for policymakers to shift their focus to boosting production, inclusive of efforts to generate additional investment and productivity gains as well as putting in place credible medium-term fiscal plans to provide essential support to vulnerable households. Lastly, central banks should communicate their policy decisions more openly to fight inflation and avert a global recession.
Copyright Journal of Business Forecasting Fall 2022