Economic Outlook – 2 October 2022


• Durable goods orders fell 0.2% in August, slightly less than the consensus forecast calling for a 0.3% decrease. Orders in the transportation category were down 1.1% as gains for vehicles and parts (+0.3%) were offset by losses for non-defence aircraft (-18.5%). Excluding transportation, orders were up a consensus-matching 0.2%, marking the sixth consecutive increase for this indicator. The report showed, also, that orders of non-defence capital goods excluding aircraft, a proxy for future capital spending, grew 1.3% MoM. This was the largest gain for this indicator since January 2022.

• Home prices retreated in July according to the S&P CoreLogic Case-Shiller 20-City Index, which slid 0.44% from the previous month, bringing its level to a three-month low. This was the worst monthly change for this indicator since December 2011 and flew in the face of consensus expectations calling for a 0.20% increase. The details of the report also showed poor diffusion, as 12 of the 20 cities covered by the index registered declines. Losses were steepest in San Francisco (-3.57%), Seattle (-2.46%), and San Diego (-2.00%). Meanwhile, Miami (+1.43%), Charlotte (+0.83%), and Atlanta (+0.60%) registered the sharpest increases, though these were all down from the previous month’s print

• Sales of new homes surprised by increasing 28.8% to 685K instead of declining 2.2% as expected by consensus (seasonally adjusted and annualized). This was the highest level of new-home sales since March 2022. Despite the jump, the number of homes available on the market was essentially steady (from 459K to a 14-year high of 461K). In turn, the inventory-to sales ratio slid from 10.4 to 8.1, which is still elevated by historical standards. It is worth noting that a high proportion of the houses available on the market were either under construction or awaiting construction. Completed houses represented only 10.3% of the total inventory, one of the lowest proportions ever recorded. This statistic reflects not so much the current health of the market as its past strength. Recall that, faced with severe labour shortages, homebuilders were unable to meet the explosion in housing demand that took place during the pandemic. As a result, construction backlogs swelled. The current context, which is much less effervescent, should allow homebuilders to quickly make up for lost time

• The Conference Board Consumer Confidence Index rose from 103.6 in August to 108.0 in September, overshooting the median economist forecast calling for a 104.6 print. The improvement reflected a more optimistic view of both the present situation and longer-term consumer expectations. The sub-index tracking sentiment towards the next six months sprang from 75.8 to 80.3, which remains low by historical standards. A higher proportion of respondents had a positive outlook on business conditions (from 17.3% to 19.3%) and employment (from 17.1% to 17.5%). Finally, the inflation rate expected in 12 months declined to 6.8%, its lowest level since January 2022. Assessment of the present situation rose from 145.3 to 149.6 as the share of respondents who considered current business conditions to be “good” was up from 19.0% to 20.8%. The percentage of polled individuals who deemed jobs plentiful increased from 47.6% to 49.4%, ending a five-month negative streak for this indicator

• The Pending Home Sales Index cooled 2.0% in August to its lowest level since 2011 excluding the pandemic period (88.4). After falling in nine of the previous ten months, the index sat 27.8% below its level in October 2021. Year on year, pending transactions were down 22.5%. This was the steepest drop registered since April 2011, outside of the pandemic period

• The core (less food and energy) personal consumption expenditures (PCE) price index, widely recognized as the Fed’s preferred inflation gauge, rose at an annualized pace of 4.7% in the second quarter—well above expectations of around 4.4% as well as the Fed’s long-term 2.0% inflation target. August’s monthly core PCE reading, released Friday, also surprised on the upside, rising 4.9% on a YoY basis, up from 4.7% in July. Long-term inflation expectations appeared to remain anchored, however, with consumers polled by the University of Michigan expecting inflation to fall to 2.7% over the next five years, the lowest reading in over a year

• Initial jobless claims dipped from 209K to 193K. Continued claims, meanwhile, declined from 1,376K to 1,347K, which is very low by historical standards. This suggests that unemployed workers were finding new jobs quickly. This assumption is supported by BLS data that show a downtrend in the median duration of unemployment spells in the United States

• This week’s financial narrative is a testament of the turbulence that’s to be expected from central banks slamming on the monetary brakes to try and rein in inflation. A relatively light data calendar over the next five weeks means that the Fed’s view is unlikely to change materially in the near-term, with another 75-basis-point hike anticipated at the next FOMC meeting in early November. The Fed is behind the inflation curve, and its policy reaction function is backward looking, rather than forward looking as with past cycles, raising the risk of policy misstep

• Turmoil in UK financial markets and signs that the Federal Reserve still has some way to go in its efforts to temper inflation sent stocks to their third consecutive weekly decline, while the yield on the benchmark 10-year U.S. Treasury note briefly breached 4% for the first time since 2008. The S&P 500 Index broke below its mid-June lows and fell back to November 2020 levels. The week closed out a third consecutive quarter of declines for the index for the first time since 2009

• Deutsche Bank’s measure of foreign exchange volatility rose to its highest level since the European sovereign debt crisis a decade ago. Major currencies, as measured by the US dollar index, are at their weakest levels in more than 20 years as global investors look for a hiding place amid extreme levels of market volatility in the bond market and rising equity vol. And it’s not just currencies: The MOVE index, which measures volatility in US Treasury yields, traded this week at its highest level since the global financial crisis. Earlier in the week, the yield on the US 10-year note brushed 4% for the first time since the early days of the GFC. Growing concerns about financial stability led investors to pare back bets on rising short-term rates as the market priced out a 25 basis point hike next year by the Fed

• In terms of data release, ISM Manufacturing Index is out on Monday. When recession fears are elevated, the ISM manufacturing index can garner extra attention for a couple of reasons. First, the ISM index for the factory sector is released at the beginning of every month, making it one of the most timely pieces of economic data. Second, the manufacturing sector is often more cyclical and prone to swings than its larger service sector counterpart. The ISM manufacturing index is currently signaling a clear slowdown in the factor sector compared to a year ago. At 52.8, the August reading was the lowest since June 2020. That said, the August report was still somewhat encouraging. The index remained above the key 50 level separating expansion from outright contraction, while some key components such as current production and new orders actually increased last month

• ISM Services Index is out on Wednesday. The service sector may be less cyclical than its manufacturing counterpart, but services account for a much larger share of the U.S. economy, and thus as its fortunes go so too does the economy as a whole. The ISM services index rose 0.2 points in August to 56.9, marking the fastest pace of expansion in the sector in four months. Most of the underlying components of the survey moved in the right direction and the headline index was buoyed by a pickup in business activity and new orders. Prior to the 2001 and 2008-2009 recessions, the ISM services index showed clear signs of rolling over, eventually falling below the key 50 level that separates expansion from contraction. For now, the ISM services index suggests the U.S. economy is not yet in a recession, and the Bloomberg consensus is for a similarly strong reading of 56.5 for next week’s release, which covers the month of September


• The Bank of England raised interest rates by 50bp and triggered active sales of its gilt holdings to speed up the process of Quantitative Tightening. Despite markets pricing in a 75bp increase, sterling remained fairly steady. Then came the Chancellor’s fiscal statement on Friday, in which he announced a fiscal loosening equating to GBP45bn per annum by 2026-27, which led to an immediate negative reaction in UK currency and gilt markets. It is widely thought that further statements made over the weekend increased market concerns about the fiscal credibility of the Government’s future plans, leading to further pressure on sterling and gilts on Monday and Tuesday. Even prior to the “mini-budget”, sterling had faced a challenging few weeks: since the beginning of August, the pound had fallen roughly 7% against the US dollar and its effective exchange rate – which compares it against a basket of currencies – had dropped by around 4% over the same period. Since the mini-budget, the pound’s effective exchange rate has fallen by roughly a further 4%. Perhaps more concerning was what was happening in the gilt market. Ten-year gilt yields, for example, jumped by more than 100bp over three days of trading following the mini-budget, well in excess of increases seen in other major European economies – including Italy, which is going through considerable political instability at the moment

• Q2 2022’s QoQ growth figure has been revised from negative to positive territory, now registering at 0.2% and up from the provisional figure of -0.1%. This means that this is not a technical recession. However, in less encouraging news, the latest set of national accounts show that GDP for Q2 2022 is below its Q4 2019 peak. This is due to a major downward revision of growth in 2020 from -9.3% to -11%. In Q2 2022, the current account deficit narrowed to £33.8bn, down from £51.7bn and considerably lower than expectations of £43.6bn. This is still historically high and continues to be driven by the cost of energy imports. August’s Bank of England money and credit publication shows net mortgage borrowing up to £6.1bn from £5.1bn in August and mortgage approvals spiking to 74,300 from 63,700. While this does not indicate a housing market slowdown, more timely Nationwide data shows that house prices held steady on a MoM basis in September, the first time this has happened since July 2021. This does suggest that rising mortgage rates are beginning to be reflected in headline house price figures


• The market fallout from the UK’s fiscal policy plans has implications for the eurozone, as member states in the bloc need to use fiscal policy more aggressively to alleviate pressures rising from the energy crisis, especially with regards to households. As of last week, the UK and major (non-Italian) eurozone 10-year yields were up by roughly 2.3-2.7 percentage points, and it’s only since then that UK Gilts have risen roughly to Italian yield levels

• Even without fiscal policy going Trussian in the eurozone, the broader market sentiment could lead to the ECB having to hold off announcing any reduction of its balance sheet (quantitative tightening, QT) for now. Recent speeches have shown some members of the ECB’s Governing Council eager to start the process of QT but in contrast to the policy rates tightening, this may be harder to reach a consensus on within the council, at least with the ongoing volatility in rates markets. The eurozone isn’t isolated from financial spillovers in higher sovereign rates which could create tighter financial conditions to the point where the ECB needs to trim views on potential rate hikes in 2023. The ECB will continue to frontload hikes, raising by 75bps in October and another 50bps in December, but holding steady afterwards as the eurozone enters into a full recession. As this economic outlook was not in the ECB’s September macroeconomic projections, the Governing Council is expected to only become less hawkish after December, when the new projections are announced. In the meanwhile, a failure on the ECB’s part to recognize growth risks could exacerbate already high signs of systemic stress – both in terms of rates volatility as well as the ECB’s own measures – putting further stress on euro assets throughout the year

• Eurozone inflation in September rose more than expected to 10 percent YoY, compared to 9.1 percent the month before. Energy is expected to have the highest annual rate in September (40.8 percent, compared with 38.6 percent), followed by food, alcohol & tobacco (11.8 percent, compared with 10.6 percent), non-energy industrial goods (5.6 percent, compared with 5.1 percent) and services (4.3 percent, compared with 3.8 percent). Meanwhile, core inflation also rose more than expected to 4.8 percent, compared to 4.3 percent the previous month. Finally, Eurostat also released the unemployment figure for August, which was 6.6 percent. The HICP releases in September (August) for major eurozone countries were as follows: France 6.2 percent (6.6), Germany 10.9 percent (8.8), Italy 9.5 percent (9.1) and Spain 9.3 percent (10.5)

• The eurozone is starting to show signs of different inflation tracks with, for example, Germany, Italy, and the Netherlands (which recorded 17.1 percent HICP inflation in September) seeing continued rising annual inflation. On the other hand, both France and Spain saw annual inflation unexpectedly slowing down, which likely capped the rise in eurozone HICP inflation

• Shares in Europe fell amid disappointing corporate earnings and fears of recession. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 0.65% lower. France’s CAC 40 Index slipped 0.36%, Germany’s DAX Index slid 1.38%, and Italy’s FTSE MIB Index dropped 1.98%


• Profits at industrial firms shrank 2.1% in the first eight months of the year from the prior year period, versus a 1.1% decline in the first seven months of the year, China’s statistics bureau reported. The Caixin/Markit manufacturing purchasing managers’ index (PMI) fell to a worse-than-expected 48.1 in September from 49.5 in August, below the 50-point reading that separates growth from contraction. Meanwhile, China’s official manufacturing PMI slightly improved in September, but services sector activity contracted as ongoing coronavirus lockdowns continued to hurt consumer spending

• The yuan traded at 7.0898 per U.S. dollar late Friday versus 7.1066 a week earlier. The currency fell to a 28-month low last Monday and has lost more than 11% against the greenback this year. The yuan is on track for recording its biggest annual loss since 1994, when China unified its official and market rates, according to Reuters. Like many emerging markets currencies, the yuan has weakened against a surging U.S. dollar boosted by the Federal Reserve’s aggressive interest rate hikes.

• The People’s Bank of China (PBOC) imposed a 20% reserve requirement ratio for foreign exchange (forex) derivative sales and warned market participants against betting on the yuan currency, according to a statement on its website. Additionally, China’s foreign exchange regulator vowed to crack down on fake forex transactions, while the state-owned Securities Times predicted that the yuan is unlikely to continue depreciating rapidly, signaling the government’s growing unease about currency volatility.

• The PBOC asked state-owned banks to prepare themselves to defend the yuan by selling dollars from their foreign exchange reserves, Reuters reported, citing unnamed sources. Such a move would mark a significant escalation in Beijing’s efforts to stabilize the yuan compared with past efforts that were largely signaling and generally ineffective in the face of U.S. dollar strength. While the proposed dollar selling may temporarily boost the yuan, it does not change the underlying dynamics weighing on the currency, in their opinion

• China’s stock markets fell as currency weakness and signs of a flagging economy fueled concerns about the outlook. The broad, capitalization-weighted Shanghai Composite Index fell 2.1% and the blue-chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, shed 1.4%, according to Reuters

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