Recession Fears Linger: A US Macroeconomic Update

Amid global tensions and ongoing supply chain issues, exports have surged during the quarter, narrowing the trade deficit and driving GDP growth.

Both consumer and government spending have also continued to rise despite interest rate hikes and high inflation. Following two consecutive quarters of decline, real GDP has been adjusted to increase an annualized 2.6% in the third quarter of 2022.

Although GDP returned to growth, recession fears have remained as the Federal Reserve has continued to increase interest rates to combat inflation.

The Inflation Reduction Act, signed into law earlier this year, will not significantly reduce inflation in the near term. While the labor market has remained strong, it will weaken as businesses respond to lower profit by cutting jobs.

Labor market

• Total nonfarm employment growth has consistently slowed over the past year, adding just 1.1 million jobs in the third quarter of 2022, in addition to another 261,000 added in October alone. Rising interest rates have driven this slowdown, which has affected corporate profit and led some companies to freeze hiring and reduce operating costs.
• While the percentage of people working remotely has continued to decline, up to 20.0% of the US labor force continues to work away from the office for reasons other than COVID-19. Remote work has been particularly popular in the Information sector and Professional Services sector.
• The unemployment rate has stagnated since the beginning of this year, which is also explained by the Fed’s aggressive monetary policy. At the same time, the unemployment rate is already low, reaching pre-pandemic levels, so further declines are unlikely. As the Fed continues to raise interest rates, the unemployment rate may increase moving forward.
• The number of jobs in the leisure and hospitality sector experienced the fastest growth. Some sectors experienced a decline, but these declines do not appear to be systematic.

Consumer spending

• Personal Consumption Expenditures (PCE), including all items, grew 1.0% during the third quarter of 2022 and 8.2% year-over-year as of October 2022 (latest data available). Growing consumer spending has largely been driven by spending on housing and utilities and transportation services.
• Spending on durable goods only increased slightly during the third quarter of 2022, rising just 0.6%. Within the durable goods segment, spending on recreational goods and vehicles; and furnishings and durable household equipment increased 2.0% and 1.6%, respectively during the same period. Conversely, spending on motor vehicles and parts decreased 1.4% during the third quarter.
• Spending on nondurable goods also minimally increased during the third quarter, primarily driven a 2.1% increase in spending on food and beverages purchased for off-premises consumption. Additionally, spending on clothing and footwear increased 1.8% during the third quarter of 2022.
• Spending on services increased 1.9% during the third quarter of 2022. Surging consumption of transportation services (3.3%) and housing and utilities (2.5%) also drove spending on services to grow during the third quarter.

Inflation

• Personal Consumption Expenditures price index (excluding food and energy), the Federal Reserve’s preferred inflation measure, increased 1.0% during the third quarter of 2022. Consequently, year-over-year inflation stands at 5.1% for the year ending in October 2022 (latest data available).
• Although the Federal Reserve monitors multiple price indexes to measure inflation, it prefers core inflation measures, which exclude volatile items such as food and energy items. While these items can experience large price changes during a given period, it does not necessarily mean their prices will follow that trend moving forward. Therefore, excluding these items is the Fed’s preferred method for assessing inflation trends.
• Inflation, as measured by the Consumer Price Index (CPI) including food and energy items, increased 7.7% for the year ending October 2022. The CPI is more commonly seen by consumers since food and energy are major spending categories for households.
• The CPI increased slightly in October 2022 compared with September 2022. This was driven primarily by a 1.8% increase in the energy index in October, following three consecutive declines. The gasoline index increased 4.0%, but the index for natural gas decreased 4.6% after increasing 2.9% in September.
• Although the energy index increased just slightly in October, year-over-year growth remains significantly elevated, rising 17.6% over the past 12 months.
• To combat the historic rise in inflation, the Federal Reserve increased interest rates in 2022 and Congress passed the Inflation Reduction Act of 2022.

Residential trends

• Surging housing prices has slowed down and even began to slightly decrease in the third quarter, resulting in housing starts growing 4.2% in 2022 compared with 4.7% in 2021.
• New home construction has continued to hold up, totaling between 1.5 million and 1.7 million units under construction. Despite mounting inflation and interest rate hikes, new home construction will remain elevated as demand persists.
• US mortgage applications have decreased in 2022 because of rising mortgage rates, dampening demand for loans to purchase homes and refinancing activity. However, as home prices began to slightly decrease as demand weakened in the second half of 2022, demand for mortgage applications slightly increased as a result.

Nonresidential trends

• Nonresidential construction has grown 1.0% compared with three months ago, driven largely by highway and street construction, manufacturing and religious construction.
• Manufacturing output is now almost back at pre-pandemic levels, driving manufacturing construction activity.
• Increasing manufacturing and industrial output has also driven highway and road construction to improve the public infrastructure. This has also been boosted by interest rate hikes that encourage manufacturing companies to replace outdated equipment as borrowing costs rise.
• The $1.2 trillion Infrastructure Investment and Jobs Act (IIJA) passed late last year, supporting programs such as the Carbon Reduction Program, a freight-related program called National Infrastructure Project Assistance Grants, a bridge repair program and electric vehicle charging infrastructure.

Financial markets

• The Federal Reserve has not stopped its monetary tightening stance, raising the target range for the federal funds rate to 3.0%-3.25% and setting the Federal Funds Effective Rate to 3.08% in the third quarter of 2022. In addition, the Federal Open Market Committee (FOMC) continues to reduce its securities holdings, which began on June 1. By selling security holdings, the committee aims to decrease the money supply within the economy. By raising the effective federal funds rate and selling securities, its goal is to reel in runaway inflation that has been driven by high retail food and energy prices. An additional 0.75% rate hike was made in November as the Federal Reserve has been taken aback by the pace of inflation.
• Fear of a harsh recession weighs heavy on investors’ minds. Recently released minutes from the November FOMC meeting have given some investors hope that the Fed will pull back the rate of these increases. However, the highly uncertain global economic and financial environment has kept markets extremely volatile.
• Increased inflation, driven by supply and demand imbalances, has resulted in interest rate hikes, contributing to the markets’ continued decline in 2022. As of October 2022, the S&P 500 is down 18.5%, NASDAQ is down 25.7%, and the DIJA is down 13.8%. Investors constantly keep tabs on inflation to monitor the severity of the Fed’s policy each meeting. Market volatility will continue until the Fed’s monetary policy shows signs of slowing down inflation.
• The trade deficit narrowed in June and July 2022. Net exports have positively contributed to GDP growth in the second quarter, and the Federal Reserve anticipates this to continue in the third quarter. Commodity prices have continued to climb amidst supply chain constraints driven by the Russian invasion of Ukraine. As countries search for alternative sources, prices are anticipated to calm. The lack of foreign industrial supplies has resulted in increased exports. In contrast, imports have declined, driven mainly by reduced consumer demand.

Distribution of risk ratings

• Following heightened risk at the start of the pandemic, risk levels tempered in 2021 as COVID-19 restrictions eased. In 2021, 25.0% of industries are rated as medium-high or greater risk.
• Risk levels have worsened in 2022 due to mounting inflation, recession concerns and ongoing supply chain issues, with 32.0% of industries rated as medium-high or greater risk in 2022.
• These concerns are expected to intensify during the outlook as inflation persists, interest rates rise and recession fears worsen. 47.9% of industries are rated as medium-high or greater risk in 2023.

Sector highlights

• Mining – As oil and other commodity prices remain elevated following persisting supply chain issues, driving inflation, the mining sector has continued to benefit. However, this poses a bleak outlook as prices fall while the global economy recovers from COVID-19, particularly threatening the Oil Drilling & Gas Extraction industry.
• Construction – Continued interest rate hikes have increased borrowing costs for construction projects, driving risk for the Construction sector over the coming years. While residential investment declined in the third quarter, funding from the Infrastructure Investment and Jobs Act (IIJA) and the Inflation Reduction Act will bolster nonresidential construction activity moving forward. The additional funding and tax credits will facilitate growth for the Water & Sewer Line Construction industry, the Road & Highway Construction industry and the Bridge & Elevated Highway Construction industry.
• Retail Trade– With the holiday season approaching, consumer spending will remain elevated, despite inflation. Meanwhile continued elevated gas prices will boost revenue for the Gas Stations and Gas Stations with Convenience Stores industries, particularly as consumers see price hikes at the pump. As inflation persists, driving up food prices, the Supermarkets & Grocery Stores industry has also experienced a boost in revenue.