Entering the fourth quarter of 2022, the economy has slowed and looks set to slow further throughout 2023 despite upward revisions of 2Q22 data. Real GDP reports annualized contractions of 0.6% and 1.6% in 1Q22 and 2Q22, respectively. However, we are still not yet in recession, and the likelihood of entering recession by yearend remains low given the strength of the labor market. And while probable we enter recession in 2023, the severity is projected to be rather muted as several key cyclical sectors of the economy are already near or slightly below their historical averages. 3Q22 Real GDP data has stabilized and the Federal Reserve Bank of Atlanta’s projections continue rise north of 2.5% annualized, up from 1.3% near the end of September.
Both effects from fiscal stimulus and the post pandemic reopening have faded and have been replaced by some major drags on economic activity. Although reductions in the federal budget deficit are healthy for the long term, this fiscal drag is slowing growth in real consumer spending with potential to slow growth elsewhere. Mortgage rates have doubled this year as home prices soared, likely to result in declines in home building, home sales, and associated spending with new households. The dollar has soared, which will boost imp orts and curtail exports, and inventories will naturally grow slowly going forward following the pandemic shortages. End of year growth estimates are currently between 0.25%-0.50%.
The September Jobs report showed the economy continues to make progress in easing labor market tightness. The recent pace of job growth remains solid at 263K but has moderated, and wage growth continues to run at a more modest pace of 0.3% month over month (m/m). Private sector job gains were broad based with the greatest strength in leisure and hospitality and health care. The unemployment rate fell back down to 3.5%. In combination with job openings falling, continued progress on job gains, particularly in the sectors with the greatest demand, is a welcome signal for investors that a more balanced labor market could put a lid on inflationary pressures and the Fed’s upward rate trajectory.
Hot inflation is beginning to cool down but continues to surprise expectations to the upside as year over year (y/y) CPI peaked in June. The September CPI report was hotter than expected, particularly following August as it had exceeded estimates as well. Headline CPI rose by 0.4% m/m while actually falling from 8.3% y/y in August to 8.2% in September. Energy prices increased by 19.8% y/y in September, smaller than the 23.8% increase reported in August. Also, the food price index increased by 11.2% among other increases in shelter, medical care, vehicle insurance, new vehicles, household furnishings, and education expenses. There were some indexes that declined, including those for used cars and trucks, apparel, and communication.
Persistent inflationary pressures have pushed the Fed to accelerate its rate hiking trajectory. At its September meeting, the FOMC announced another 0.75% increase in the federal funds rate to a range of 3.00%-3.25%. In its updated dot plot, the committee expects to lift rates to 4%-5% next year and doesn’t expect to begin lowering rates until 2025. The tone of the committee remains hawkish (those who support high rates) with a focus on taming inflation that runs well above its 2% target. Strong job growth and persistent excess demand for labor suggest a soft landing is still possible. However, aggressive Fed tightening keeps the probability of recession sometime next year elevated.
The euro area now expects to enter recession in 4Q22, and GDP estimates are negative for 4Q22 and 1Q23. Full year growth between 2%-3% is still expected, and consumer sentiment is depressed. Primary risks stem from Russia’s invasion of Ukraine and recent halt of natural gas flows previously supplying more than a third of the area, and hawkish central banking policies regardless of recession.
China’s full year growth estimates have been downgraded again after recent 3Q22 consumer spending data fell well below projections. Additionally, the executive committee signaled willingness to accept any real economic growth, effectively removing official growth targets for yearend. However, 4Q22 data could be more robust due to a variety of reasons, potentially averaging positive growth between 2.5%-3.5% for the year.
Recent IMF estimates for full year growth in emerging markets land between 3%-3.5%, though widespread central bank tightening concurrent with slowing global growth could present significant headwinds. Emerging Europe has the most at risk as prohibitive energy prices sparked additional interest rate hikes.