With each passing month, the economic slowdown that began in the first quarter of 2022 is becoming more evident in more and more sectors of the economy. Although elevated inflation is a lagging indicator, the Fed remains focused on tightening funding conditions to slow demand growth. The fed funds rate has now been raised a whopping 3% since the start of the year and the continued reduction in the Fed’s balance sheet is reducing liquidity in the economy and markets.
The August CPI, released in mid-September, rose 8.3% year-on-year. Although down from 8.5% in July, it remains elevated and was higher than expected. The main focus of attention was the rise in core CPI (excluding food and energy), which rose 0.6%, double forecast, resulting in an annual reading of 6.3%, versus 5.9% in July . The accommodation component accounts for 41% of core CPI and is the main upward pressure on this metric. Although rents are beginning to ease, their impact is unlikely to be reflected in weaker core inflation until next year.
Inflation-adjusted disposable personal income was negative for nine straight months year-on-year. This has caused consumers to reduce their savings rate to the lowest level since 2008. This level of contraction in savings suggests that consumer spending is likely to continue to contract for the foreseeable future.
The final numbers for the second quarter’s economic growth showed that real GDP contracted at an annual rate of 1% in the first half of 2022. The contraction in real GDP was primarily driven by a fall in real private domestic purchases from 6.7% last year to a 1.3% annualized rate in the first half of this year.
On October 5, OPEC announced its decision to cut oil production quotas by 2 million barrels per day (bpd) from 43.9 million bpd to 41.9 bpd. More than a policy move to keep energy prices high, it reflects falling demand for oil as the global economy slows. Higher energy prices will only slow down the decline in general inflationary pressures.
Leading economic indicators for August fell for the sixth straight month, thus forecasting an imminent recession.
work and living
The September jobs report showed that nonfarm payrolls slowed for the second straight month. The number of employees increased by 263,000 compared to the increase of 315,000 in August. The labor force fell by 57,000, causing the unemployment rate to drop to 3.5%, down to pre-pandemic lows. Average hourly earnings slowed to an annualized rate of 4.4% in the third quarter, compared to 4.6% in the second quarter. Adjusted for inflation, average weekly earnings were flat or negative for 9 of the last 11 months and is -3.4% year-on-year.
The slowdown in the job market was also highlighted by the 1.1 million drop in job openings, according to the August Job Openings and Labor Turnover Survey (JOLTS). Vacancies have declined in four of the last five months. The ratio of vacancies to unemployed fell from 2.0 to 1.7.
Residential construction has so far borne the brunt of the rise in interest rates. Mortgage rates have doubled this year and house prices are starting to fall. Unsurprisingly, mortgage applications for purchases are down 37% year over year.
On the back of this softening economic news, the Fed raised the Fed Funds rate by 75 basis points (bps) to 3.25% at its September 21 meeting, and markets expect the rate to rise further by a total of 1% by the end of the year, 25% come from their November and December meetings. Interest rates are at decade highs and the 2-10 year portion of the yield curve has inverted the most since the early 1980s. The banks are also tightening their lending standards for almost all loan categories. The availability of credit is decreasing and its price is increasing. All of this points to slower economic growth.
The Fed has made it clear that it intends to keep monetary policy in a tightening mode until it is confident that inflation is moving back towards its 2% target. The Fed is tightening monetary policy in an economy that is already slowing, and with the full impact of Fed action taking 12 to 18 months to hit the economy, a 2023 recession is highly likely.