Real GDP shrank in the first quarter of 2022, but monthly data suggests there may have been solid growth in the second quarter and spending picked up in Covid-impacted sectors like travel and entertainment.
The third quarter, however, isn’t looking so hot, says David Kelly, chief global strategist at JP Morgan Asset Management. He sees storm clouds gathering that threatens to seriously temper economic momentum.
David Bianco, chief investment officer for the Americas at DWS Group, says his team has already trimmed GDP forecasts several times over the course of the year.
“In past cycles investors and economists would tend to focus on the demand side: How strong is the consumer?” he said on a recent call with reporters. “People make the arguments that the economy’s fine right now because the consumer is healthy. Our argument would be that this is an environment where the focus should be on the supply side.”
“The underlying problem is that inflation has been a function of not enough supply versus too much demand,” wrote Ivan Feinseth of Tigress Financial Partners in a note.
But faltering demand could become a bigger problem. An end to stimulus checks, enhanced illness benefits, enhanced child tax credits and other programs that aided lower and middle-income households during the height of the pandemic could cause a drag on spending in the near future, Kelly said.
Kelly predicts that the end of these stimulus programs could lead to a drop in the federal budget deficit from 12.4% of GDP in 2021 to less than 4% of GDP in 2022. That would be the largest decline since the end of World War II.
Add to that a surge in 30-year mortgage rates, an 8% increase in the dollar against key currencies this year that makes exports more expensive and dropping consumer confidence and you’ve got a fairly heightened “risk that the US economy falls into recession” in the near term,” Kelly said.
Boris Johnson and the falling pound
Chancellor of the Exchequer Rishi Sunak and UK Health Secretary Sajid Javid turned in their letters of resignation via Twitter within minutes of each other on Tuesday evening. Johnson has weathered multiple storms during his time as prime minister, but this may be one crisis too many.
Speculation is now swirling about a renewed bid by his own lawmakers to unseat him, possibly as earlier as next week.
“When your chancellor and health secretary both resign — it’s only a matter of time before a prime minister is out,” Jordan Rochester, a strategist at Nomura International, wrote in a note Tuesday.
The pound fell about 1.5% against the US dollar on Tuesday and remained mired near its lowest level since March 2020 on Wednesday. The cabinet changes likely won’t impact the pound in the short term, Rochester said, but the political instability caused by Johnson may do so.
The world’s fifth biggest economy ground to a halt in February and started shrinking in March. Retail sales fell in May for the second consecutive month. The Bank of England has already raised interest rates five times and is promising more to tackle soaring inflation that could peak above 11% later this year, piling on the pain for millions struggling with a cost-of-living crisis.
Many of Johnson’s critics, including some in his own party, believe he doesn’t have the answers.
In his letter of resignation, finance minister Sunak cited insurmountable differences with Johnson on the economy.
“In preparation for our proposed joint speech on the economy next week, it has become clear to me that our approaches are fundamentally too different,” Sunak wrote. “I am sad to be leaving government but I have reluctantly come to the conclusion that we cannot continue like this.”
It would only be possible to deliver a low-tax, high-growth economy and strong public services if Johnson was prepared to “take difficult decisions,” he went on. “Our people know that if something is too good to be true then it’s not true.”
A hard landing and softening inflation
Inflation remains at 40-year highs and the Federal Reserve shows no sign of slowing down its rate hikes to rising combat prices, while consumer confidence is at record lows. Even Fed Reserve Chair Jerome Powell has admitted that a soft landing will be exceedingly difficult to achieve.
But there may be a small beacon of hope. It appears that fear of an economic downturn has been enough to ease fears of inflation.
Jeffrey Buchbinde and Jeffrey Roach of LPL Financial see some signs of a post-peak inflation world:
- The inflation rate implied by TIPS, a type of Treasury security issued by the US government, over the next five years has fallen from 3.1% to 2.6% in the last month, down from a peak of 3.7% earlier this year.
- New supply chain data from the New York Fed indicates that supply bottlenecks are easing.
- US inflation expectations, as per the St. Louis Federal Reserve, have dropped to their lowest levels in nearly a year.
- In June, the University of Michigan survey of consumers’ long-term inflation expectations fell from 3.3% to 3.1%.
- Oil prices are down over 10% since June 8, which will hopefully translate into lower prices at the pump soon.
US ISM non-manufacturing index; US Fed minutes from June meeting.