Economic Outlook – 11 September 2022


• The short week following the Labor Day holiday was a relatively quiet one for U.S. economic data, sandwiched between last week’s employment report and next week’s critical CPI release. On Tuesday, the ISM services index topped expectations. The index registered a robust 56.9 reading, and the subcomponents were equally encouraging. Both the business activity and new orders components were the strongest readings of 2022, while the prices paid component ticked lower. The index has come off its record highs reached in 2021, but it remains well above the key 50 level that separates expansion from contraction, and it is about a point higher than the average over the 2010s. This week’s ISM release provides further support for the belief that the U.S. economy has decelerated but has not yet fallen into a recession

• Initial jobless claims came in a bit cooler than expected, although continuing claims were a bit worse than anticipated. Data on individuals filing for unemployment do not suggest the economy is currently in a recession. Claims have ticked higher, but off of an incredibly low base amid a historically tight labor market. Even with the recent increase in continuing claims, the total number of people collecting unemployment benefits is still roughly 300K below February 2020 levels. For now, the jobless claims data are sending a similar signal to the ISM services index: The U.S. economy is slowing down but not outright contracting

• Much has been made about the extent to which consumers have needed to lean on their balance sheets to sustain consumption through the sky-high inflation seen thus far in 2022. This can come in the form of leaning on the asset side of the balance sheet (e.g., spending down your savings) or leaning on the liability side of the balance sheet (e.g., taking on new debt). For the latter, some ostensibly scary headlines have emerged related to credit growth, specifically about revolving credit such as credit cards. Data released this week showed revolving credit was up 14.3% YoY in July. However, a deeper dive reveals that this rapid pace of growth may not be as concerning as it seems. Yes, revolving credit growth has been strong of late, but consumers paid down a significant amount of credit card debt earlier in the pandemic. From February 2020 through February 2021, consumer revolving credit outstanding fell 11.7%. As a share of after-tax household income, total revolving credit is still below its pre-pandemic ratio. Of course, with both borrowing and interest rates on the rise, eventually consumers will need to find a more sustainable source of funds for consumption growth. But for now, the recent rise in credit card debt is more of a normalization relative to the pre-pandemic trend rather than a significant cause for concern

• The tightness of labor market is a big part of why the Fed takes a hardline inflation fighting stance. FOMC speakers took every opportunity to reinforce their unanimity on this front ahead of the central bank’s black-out period prior to its September 21st rate decision. Chair Powell was very explicit by stating that the Committee wants to soften growth enough to “cause the labor market to get back into better balance, and then that will bring wages back down to levels that are more consistent with 2% inflation over time.” Investors heard it loud and clear with the federal funds futures markets now have greater conviction that the Fed will hike 75 basis to 3.25%. Moreover, the market appears less convinced that there will be rate cuts next year, buying into the Vice Chair Brainard’s “we are in this for as long as it takes to get inflation down” mantra

• The Fed’s Beige Book shows that the outlook for future economic growth remains generally weak, with demand expected to soften over the next 6 to 12 months. The report, put together in advance of the 20 and 21 September meeting of the FOMC, says that price levels remain highly elevated but that some Fed districts note a degree of moderation in the rate of increase

• The trade deficit narrowed for the fourth month in a row in July, moving from $80.9 billion to a nine-month low of $70.6 billion. The decline was due to a 3.0% decrease in goods imports to $274.1 billion, led by a drop in pharmaceutical preparations (-$3.0 billion), toys, games, and sporting goods (-$0.9 billion), and other petroleum products (-$0.7 billion). Goods exports, for their part, shrank 0.2% to $183.0 billion as decreases for natural gas (-$1.3 billion), foods, feeds, and beverages (-$1.3 billion), and other petroleum products (-$1.0 billion) were only partially compensated for by gains for nonmonetary gold (+$2.0 billion), passenger cars (+$1.0 billion) and other industrial machinery (+$0.6 billion). Overall, the goods trade deficit went down from $99.3 billion to $91.1 billion. On a country-by-country basis, the U.S. goods deficit narrowed with China (from $36.9 billion to $34.4 billion) and Mexico (from $11.0 billion to $10.5 billion) but increased with Canada (from $7.8 billion to $8.6 billion) and Japan (from $4.6 billion to $5.6 billion)

• Stocks broke a string of three weekly losses, as investors appeared to grow more confident that the market had reached at least a temporary bottom after surrendering about half of its summer rally. Some moderating inflation fears may have also been at work, and a midweek decline in oil prices—which briefly hit their lowest level since Russia’s invasion of Ukraine—caused energy shares to underperform within the S&P 500 Index, although the sector still recorded a gain. A rally in heavily weighted Tesla helped the consumer discretionary sector outperform. Markets were closed Monday in observance of Labor Day

• In terms of data release, CPI is out on Tuesday. Consumer price inflation surprised to the downside in July, driven by a big drop in energy prices and a sharp slowdown in both core goods and services. Tuesday’s report is expected to show consumers received further relief on the inflation front in August. Specifically, might prices to have declined 0.2% last month, which would be the largest monthly drop since the spring of 2020. A further plunge in gasoline prices is expected to lead the headline lower, while additional giveback in travel services and used cars should help hold the core to a 0.4% MoM increase

• Retail sales print is out on Thursday. Sales were flat in July, but after accounting for price changes, real sales are expected to rise 0.6%—the first volume gain in three months. Nominal sales likely dipped 0.2% in August, held down by a double-digit decline in gasoline prices last month and a slight decline in vehicle units sold. Savings at the pump, however, are likely to have supported sales in other categories as back-to-school shopping went into full swing

• A sizable rebound in auto assemblies in July helped drive industrial production to its biggest gain since March. Some payback is expected in August and for total industrial production to slip 0.1%. July historically has been a time for auto manufacturers to retool plants, but with fewer shutdowns as supplies are becoming easier to get a hold of, favorable seasonal factors likely contributed to last month’s 6.6% rise in motor vehicles and parts production. Those adjustment factors will not be so favorable in August when production historically climbs, even as the latest ISM supplier delivery index points to genuine improvement in parts delivered to the industry at the center of the supply shortages the past two years


• The UK now has its fourth Prime Minister in just over six years and there is likely to be a general election by the spring of 2024. The new Prime Minister, Liz Truss, is very different from her predecessor, being more ideologically wedded to free markets and small government than any premiere since Margaret Thatcher. That said, one area of agreement between Johnson and Truss is over the UK’s support for the Ukraine, so expect no change there. Truss made her name as the trade minister, she voted to Remain, but has since been enthusiastic in seeking post-Brexit opportunities and signing a series of free trade agreements around the world. Importantly, Truss firmly believes that tax cuts will have a stimulative effect on the economy. The new PM’s announcements is likely to come in three waves: immediate, in the next few days; at an emergency budget, sometime in the next month; and ideas set out in the next electoral manifesto, things that she would like to put in place were she to win a fresh mandate in 2024

• The broad backdrop of the cost of living crisis has to be addressed immediately. Rocketing energy prices, steep tax rises, and rising interest and inflation rates, have all combined to send the GfK consumer confidence down to 47 year record low levels. Over the course of the leadership campaign, Truss has made pledges to reverse tax rises which were scheduled to take the tax burden to levels last experienced in the late 1940’s: chiefly she is looking to reverse the recently introduced 1.25 percent increase in National Insurance and forego the planed hike of Corporation tax to 25 percent. These two moves will cost the exchequer in the region of GBP 25bn. Issues such as the green energy levy will also be looked at to see if there are other ways to meet environmental targets. There has also been discussion about a review of business rates, inheritance tax and taxation of the self-employed. These discussions have been notably short on details. Longer term in a future Parliament, Truss wants to set out a long-term plan for the economy, including setting out a long-term plan to repay pandemic-related debt. This is also when issues such as reviewing the Bank of England’s 25 year old mandate would be considered, although any change to operational independence is not being contemplated

• Bank of England (BoE) Chief Economist Huw Pill hinted in testimony to Parliament that the government’s energy bailout plan could force the central bank to raise interest rates further. Asked by MPs whether the package would mean higher rates, Pill replied: “In response to the question, will fiscal policies generate inflation—we are here to ensure that they don’t generate inflation…Our remit is to get inflation back to target.” “We do have work to do,” he added

• The British pound depreciated further against the U.S. dollar before retracing to roughly USD 1.16, a level near the low hit in 1985. This weakness appeared to stem, in part, from uncertainty about the economic agenda of new UK Prime Minister Liz Truss


• The Governing Council decided (unanimously) to raise policy rates by 75 basis points. In describing the rate hike, the ECB also made explicit statements about:

– Front-loading: “this major step front-loads the transition from the prevailing highly accommodating level of policy rates towards levels that will ensure the timely return of inflation to the ECB’s 2% medium-term target.”
– More rate hikes to come: “over the next few meetings, the Governing Council expects to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations.”
– Guidance about lack of guidance: “The Governing Council will regularly re-evaluate its policy path in light of incoming information and the evolving inflation outlook. The Governing Council’s future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach.”

Meanwhile, in somewhat of a surprise, the two-tier system was suspended by setting the multiplier to zero, but no reverse-tiering system was announced. President Lagarde said that the ECB would conduct an overview of TLTRO conditions and reserve remuneration “in due course”

• In the press release, the ECB said it expects the economy to slow down substantially over the remainder of this year. It also noted elevated levels of underlying inflation. “At the same time,” it stated, “incoming data and recent wage agreements indicate that wage dynamics remain contained overall” and “Most measures of longer-term inflation expectations currently stand at around two per cent, although recent above-target revisions to some indicators warrant continued monitoring.”

• The ECB significantly raised its inflation outlook, with 2022 HICP inflation at 8.1 percent, 2023 inflation at 5.5 percent, and 2024 inflation at 2.3 percent. This marks a 2pp and 0.2pp upward shift respectively for the latter two years, and likely a contributing factor to the 75bp hike. Core inflation was also revised upward with annual changes at 3.9 percent, 3.4 percent, and 2.3 percent for 2022 through 2024 respectively. The ECB still does not perceive a recession in the eurozone, seeing 3.1 percent GDP growth in 2022, 0.9 percent in 2023, and 1.9 percent in 2024

• Shares in Europe rose after some countries announced plans to deal with the energy crisis and boost their economies. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 1.06% higher. Major indexes also posted gains. Germany’s DAX Index rose 0.29%, France’s CAC 40 Index advanced 0.73%, and Italy’s FTSE MIB Index added 0.79%


• China’s consumer and factory gate inflation in August declined from July’s levels and came in below analysts’ expectations. Consumer prices rose 2.5% over the 12 months ended in August, while factory gate prices rose 2.5%, down sharply from 4.2% the previous month. Year-over-year factory gate inflation (which excludes any transport or delivery charges) peaked at 13.5% in October 2021 and has trended consistently lower since. Earlier in the week, official data revealed that exports and imports lost momentum in August as surging inflation curbed overseas demand, while coronavirus restrictions and heatwaves disrupted China’s output

• The People’s Bank of China (PBOC) set firmer-than-expected guidance for the yuan exchange rate against the U.S. dollar for the 13th straight trading day, a move viewed by analysts as part of the government’s efforts to slow the pace of the currency’s depreciation. Each trading day, China’s central bank releases a so-called daily fixing against the dollar, a reference rate for the onshore yuan that limits its moves by 2% in either direction. Analysts regard any significant discrepancy between the market’s expectations of the fixing and where the PBOC sets the midpoint as a policy signal of how Beijing wants to influence the currency. Last Friday, the yuan recorded its fourth weekly loss against the dollar, according to Reuters, and is down nearly 8% against the greenback this year as of the end of August

• China cut the amount of foreign exchange that domestic banks must hold in reserves, a move seen as an effort to bolster the yuan. Financial institutions will be required to hold 6% of their foreign currency deposits in reserves starting September 15, down from the current 8%, according to a PBOC statement. However, the Securities Finance Times, a state-backed news outlet, said that the PBOC is more concerned about the pace of the yuan’s depreciation than with a specific exchange rate

• China’s stock markets rose as tame inflation data and expectations of further policy support prompted buying. The broad, capitalization-weighted Shanghai Composite Index advanced 2.4%, and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, added 1.7%, Reuters reported

Sources: T. Rowe Price, MFS Investment Management, Wells Fargo, Handelsbanken Capital Markets, National Bank of Canada, M. Cassar Derjavets