Economic Outlook – 25 September 2022


• The Federal Reserve hiked the target range for the federal funds rate 75 bps to 3%–3.25% and will continue to reduce its holdings of Treasuries via a quantitative tightening process, with monthly caps doubling as previously telegraphed. The interest rate on reserve balances increased an equivalent 75 bps to 3.15%. There were no dissenters among participants at the meeting. This is the Fed’s third successive 75-bp hike and its fifth move total, bringing cumulative policy rate tightening to 300 bps (and counting). A parsing of the statement reveals a clear, necessary and ultimately unchanged focus on inflation. The new statement echoes the previous one when it states: “inflation remains elevated” (for a variety of reasons). Consequently, the FOMC remains “highly attentive to inflation risks” (again no change vs. prior statement). Finally, the statement once again underscores a strong commitment to bring inflation back down towards the Fed’s 2% target. There was a modest change to the characterization of economic growth. Recent indicators point to “modest” growth in spending and production, whereas the prior statement indicated some softening in this regard. Job gains, for their part, have been “robust”. Finally, the ongoing war in Ukraine was causing hardship and contributing to upward inflation pressure. In terms of guidance, the statement once again indicated that “ongoing increases in the target range [would] be appropriate”. As before, the Committee is prepared to adjust its policy stance in the face of evolving risks, with the assessment taking a wide range of indicators into account, notably “readings on public health, labour market conditions, inflation pressures and inflation expectations, and financial and international developments

• September’s rate decision was accompanied by the FOMC’s Summary of Economic Projections, which includes the closely monitored dot plot, with the projection timeline extended to 2025. While there was much to take in here, one highlight was a notable upward shift in the assumed level for the fed funds rate. Despite a material downward revision to GDP growth, FOMC participants now saw the upper limit of the fed funds target range ending 2022 at 4.5%. This implies a further 125 bps of tightening in the final two meetings of the calendar year, though a fair number of participants (8 of 19) favored instead an increment of 100 bps. Furthermore, the median fed funds rate (upper limit) projection for the end of 2023 was lifted to 4.75%, at least 75 bps higher than in June

• Fed Chair Jerome Powell spent much of the press conference reinforcing a three-pronged message: inflation is too high, rates need to get into meaningfully restrictive territory (and fast), and the Fed will not rest until inflation is quelled (even if it means inflicting economic damage). The central banker exhibited the utmost resolve through a tone and demeanor reminiscent of the speech he gave at Jackson Hole. He was repeatedly asked how much “pain” the Fed was willing to tolerate. The answer: As much as is necessary to get inflation back to target. While he conceded that monetary policy operates with long and variable lags, it was clear to him (and the Committee more broadly) that they still had a ways to go regarding the policy rate. He noted, for instance, that after this week’s hike, the fed funds rate was still only at the lowest level of restrictive. Consequently, they were fully prepared to keep at it (hiking, that is), as evidenced by the dot plot, which suggests a willingness to hold in restrictive territory through 2024. They will begin contemplating cuts seriously only when they are very confident that inflation is moving back down to 2%. They were not overreacting to one figure or report in particular: Inflation was simply not where they expected or want it to be. However, regarding the fact that core PCE inflation was currently at a lofty 4.5%, he quipped: “You don’t need to know much more than that.”

• Housing starts shot up to 1,575K in August, a much bigger hike than expected by economists (1,450K). The jump reflected a significant increase in the multi-family segment (+28.0% to 640K) and a smaller one in the single-family segment (+3.4% to 935K). Building permits, for their part, dropped 10.0% to 1,517K, their lowest level since June 2020. Outside of the pandemic period, it was the biggest monthly decline since August 2015. The drop was caused by decreases in both the multi-unit and the single-family segment, -17.9% to 618K and -3.5% to 899K, respectively. Meanwhile, the number of authorized residential projects for which construction had not yet started slid from 298K to 290K, which was still near a 50-year high. In normal times, such a number of unexercised permits signifies booming activity in the residential sector and the inability of builders to meet demand. Under current market conditions, however, it is unclear whether the figure reflects instead a loss of confidence among builders, who now perhaps prefer to leave a few projects on ice while waiting to see how the situation unravels

• Homebuilder sentiment, meanwhile, is sliding fast. In September, the National Association of Home Builders Market Index fell 3.0 points to 46.0. Outside of the pandemic period, this is the lowest print since May 2014. NAHB data also showed a decline in prospective buyer traffic. Together, these data suggest that there could be more pain in store for residential construction going forward

• Existing-home sales dipped only 0.4% in August to 4.80 million (seasonally adjusted and annualized), for a total drawback of 26.2% over seven months. Excluding the first months of the pandemic, this was also the lowest level of sales observed in nearly seven years. The 4.0% increase in condo sales was outweighed by the 0.9% decrease in single-family dwellings. After increasing for the past six months, the inventory-to-sales ratio held steady at 3.2 in August. Despite the recent increase, the ratio remained low on a historical basis (at <5 it indicates a tight market according to the National Association of Realtors), as supply continued to lag. In fact, the inventory of properties available for sale totalled just 1.28 million (not seasonally adjusted), the joint-lowest level ever recorded in a month of August. Given the scarce supply, listed properties stayed on the market no more than 16 days on average, up slightly from 14 days in July, the shortest time on records

• The S&P Global flash composite PMI jumped from 44.6 in August to 49.3 in September, a 3-month high signalling a softer and marginal decline in private sector business activity. New orders return into expansionary territory, driven by both the manufacturing and service sector. However, the rate of expansion was subdued by inflationary pressures who continued to weigh on customer spending. On the bright side, input cost inflation eased during the month to its slowest pace since the start of 2021. However, “Cost burdens continued to rise at an historically elevated pace, with interest rate hikes and material and wage increases driving inflation.” That slower rate of increase in input price was translated into a slower pace of increase in selling price as well. Business expectations for the year ahead picked up to a four-month high and was only just below the series trend, thanks to “hopes of further upticks in new orders and the acquisition of new customers

• The Leading Economic Index (LEI) has signaled a broader loss of momentum across the economy. The LEI decreased 0.3% in August, pushing the six-month average change to -0.46%, below the historical recession threshold of -0.4%

• In a 60 Minutes interview last Sunday, US President Joe Biden repeated that the US would defend Taiwan in case of an attack by China and said he would block US investment in China if Beijing were to support Russia against Ukraine. Biden also declared that the pandemic is over

• Stocks recorded a second week of pronounced losses after Federal Reserve policymakers revealed that they expected official short-term interest rates to continue going sharply higher over the next several months. The Dow Jones Industrial Average and S&P 400 Midcap Index fell to new intraday lows since late 2020, while the S&P 500 Index, small-cap Russell 2000 Index, and Nasdaq Composite managed to stay slightly above their bottoms in mid-June 2022. The Cboe Volatility Index (VIX), Wall Street’s so-called fear gauge, stayed more firmly below its spring highs but rose sharply at the end of the week. The technology-heavy Nasdaq Composite Index fared worst for the second consecutive week and briefly fell to a level more than one-third below its January record high

• In terms of data release, durable goods orders are out on Tuesday. Most measures of manufacturing activity suggest the sector is losing momentum. Industrial production fell 0.2% in August, with manufacturing output up just 0.1%. But even as the need to fulfill some backlog may keep manufacturing modestly afloat, new demand is stumbling. The ISM manufacturing new orders index has been teetering between expansion and contraction the past three months, and adjusting core capital goods orders for the run up in the prices of private capital equipment puts real orders down at a 2.5% average annualized pace over the past three months

• Consumer confidence is out on Tuesday. The index has buckled amid high inflation and increased economic uncertainty. While those two concerns have not disappeared, a modest improvement in September is expected. The preliminary read from the University of Michigan on consumer sentiment showed a modest gain in part due to falling gas prices. While the two surveys do not always move together, its is possible lower price at the pump also helped boost the Conference Board’s measure of confidence last month. That said, the state of the labor market is of much more interest for the confidence survey. Most measures of the labor market have shown some signs of topping out, with job openings and hiring plans moving sideways in recent months, and the share of consumers who view jobs as plentiful, which comes from the confidence survey, also rolling over


• Following a downward trajectory since November 2021, consumer confidence plunged to a new record low of -49 in September, dropping from -44 in August and far below consensus of -42. With the exception of the major purchase index – which remained flat – all sub-metrics reported falls: for example, the personal financial situation index over the next 12 months fell by 9 points and the equivalent general economic situation index fell by 8 points. The record low consumer confidence reading comes despite some of the responses to the survey registering after the announcement of an energy price cap. PMI release shows UK business activity declining at the quickest rate since January 2021, owing to cost pressures and weakening demand. The Flash Composite PMI – which measures both services and manufacturing – registered at 48.4 in September, falling from 49.6 in the previous month. The figure is considerably below 50 and therefore provides a firm indication of contracting business activity. Having been in expansionary territory, the UK services PMI has slipped below 50 to 49.2, dropping from 50.9 in August. UK manufacturing PMI is at 48.5 and the manufacturing output index is at 44.4

• The new Chancellor Kwasi Kwarteng presented a “fiscal event”. This is not a Budget, but set out a number of immediate changes to the tax code that are aimed at getting the economy growing once again. National Insurance (which is essentially income tax by a slightly more palatable name), which rose by 1.25% for individuals in the Spring, has now been reversed. This reversal will come into effect from November. The government has also cancelled the Health and Social Care levy – whether this means that the Government will be backing away from the promise to pay for long term care remains to be seen. The planned rise in Corporation tax, from 19% to 25%, which had been set to take effect this autumn, is now cancelled. The basic rate of income tax is now due to fall from 20% to 19% in April 2023. The top rate of income tax is to be lowered from 45% to 40% from April 2023. The top rate of tax had been raised in the dying days of the last Labour government and the incoming coalition government felt that politically they could only lower this to 45%. This has now been lowered to 40%, the level the Treasury had for some twenty years said was the point of revenue maximisation. The actual rate paid is slightly higher, as 2% of NI remains uncapped. Stamp Duty on property is to have its nil rate band increased from £125k to £250, and first-time buyers will not pay until a home costs more than £425k (from £300k). The UK property market seems set to slow over the coming year as the house prices to value ratio was at an all-time high and affordability, as measured by mortgage cost as a percent of income, had been rising alongside interest rates. Lowering transaction costs will be welcomed by buyers, judging by the impact of similar moves during the Covid Pandemic. However, lower transactions costs will not in and of themselves be sufficient to put the housing market on a more sustainable path. That will need planning reform, which itself tends to be contentious


• The S&P Global flash composite PMI fell from 48.9 in August to 48.2 in September, signalling a third successive reduction in business activity in the single-currency area. New orders fell sharply, resulting in a declining work backlog for a third month in a row. Employment growth was unchanged in September, while August’s gain had been the lowest in 17 months. Input cost inflation increased to the strongest pace since June as the easing in raw material supply constraints were overweight by increasing energy cost. Higher input cost pressure meant that, after four months of cooling, the rate of increase of price charged also accelerated to the sharpest since June. Supplier delivery times, meanwhile, lengthened the least since October 2020

• France experienced a pick-up in economic activity this month, although underlying drivers remained weak. In particular, services growth picked up whereas high inflation, overstocked warehouses and weakening demand led to a further sharp decline in manufacturing. Similar factors drove down further composite activity in Germany, especially due to a softening in the services sector. Judging by the PMIs throughout the third quarter, GDP in Germany looks set to contract during this period

• Deteriorating activity was observed in both manufacturing and services, with demand falling faster in each sector as a result of the rising cost of living and increasingly gloomy future prospects. Soaring energy prices added further to company costs, and appear to have limited production in some cases, pushing survey price hikes higher – indicating further acceleration of inflationary pressures. New orders fell in both sectors, and future expectations took a large dive, especially in the manufacturing sector. And whereas supply chain pressures showed further signs of easing, in both sectors input and output prices rose significantly compared to the previous month

• European shares fell sharply for a second week, as central banks raised interest rates sharply, intensifying fears of a prolonged economic slowdown. The pan-European STOXX Europe 600 Index ended the week down 4.37%, dropping to the lowest levels in more than a year. Major indexes also tumbled. France’s CAC 40 lost 4.84%, Germany’s DAX slid 3.59%, and Italy’s FTSE MIB 4.72%


• An increasing number of economists have dialed back their growth forecasts for China, where the economy faces persistent headwinds from a property market downturn and continued coronavirus outbreaks. The Asian Development Bank was the latest to downgrade its growth estimate for China to 3.3% this year from a prior 4.0% estimate. It also forecast that China’s economic growth would lag that of developing Asia for the first time in more than three decades. Beijing’s official growth target this year is about 5.5%, a level that many economists believe is unattainable

• The PBOC kept its benchmark lending rates unchanged at a monthly meeting. The central bank left the one-year and five-year loan prime rates unchanged after unexpectedly cutting both rates in August. The 10-year Chinese government bond yield rose to 2.713% from 2.692% the prior week as U.S. Treasury yields hit 11-year highs. The yield gap between the benchmark 10-year U.S. Treasury bond and its Chinese counterpart widened to the highest since 2007, Reuters reported

• Many regard any significant discrepancy between the market’s expectations of the fixing and where the PBOC sets the midpoint as a signal of how Beijing wants to influence the currency. The Fed’s aggressive tightening has boosted the dollar at the expense of the yuan and other emerging markets currencies this year. China’s surprise decision to lower key interest rates in August has also fueled the yuan’s slide

• The yuan currency fell to a near 28-month low and traded at 7.1066 per U.S. dollar versus 7.0185 a week earlier, according to Reuters. The People’s Bank of China (PBOC), which sets a reference rate each trading day for the onshore yuan versus the U.S. dollar, set the so-called fixing at its lowest level since early August 2020, according to Reuters. The onshore yuan can trade up to 2% on either side of the fixing. However, the central bank has set the fixing stronger than market expectations in every single session for almost a month, indicating China’s efforts to slow the pace of depreciation

• China’s stock markets fell as global growth slowdown fears gripped investors. The broad, capitalization-weighted Shanghai Composite Index slipped 1.2%, and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, dropped 1.9%, Reuters reported

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