Economic Outlook – 3 July 2022


• Consumer prices measured by the PCE deflator rose another 0.6% in May, lifting the annual rate back up a touch to 6.35% from 6.29% previously. Elevated and persistent price pressures have dramatically weighed on real disposable personal income, which is now about 5.4% below where it would be implied by its trend in the absence of the pandemic. That’s a dramatic hit to income, and it’s weighing on consumers’ ability to spend. Real personal spending slipped 0.4% as a result in May, even as consumers continued to save less compared to pre-pandemic habits. While consumers still have room to tap sources of staying power, the May data suggest it may be running out. Piling onto the weak spending data were that measures of consumers’ confidence moved sharply lower in June as consumers grow particularly pessimistic on what’s to come. The expectations component of the consumer confidence index, for example, slid 7.3 points to 66.4 in June, which marks the largest monthly drop in over a year and a half and the lowest reading for expectations in nine years. The deterioration in confidence is not surprising amid elevated gas prices, deteriorating labor market prospects and simply broad concern over finances, and it presents a notable shift in consumer psyche

• With consumers’ spending habits transitioning to more normal patterns, goods spending accounted for just 39.1% of total spending in May, which marks the lowest share of spending dedicated to goods in the two years since the start of the pandemic. One positive of a pullback in spending is that a pronounced pullback in goods consumption specifically is alleviating some pressure on supply chains. Real inventories rose for the eighth consecutive month in April, driven by gains in wholesale and retail inventories specifically. As demand cools, retailers should be able to more easily restock depleted inventory

• While new orders for durable goods continued to rise in May, the ISM manufacturing survey for June was pretty weak. A slowing economy and rising interest rate environment are not favorable backdrops for capex, and demand is expected to slow. The new orders components of the regional Fed PMI surveys slid lower generally across the board for June, which foreshadowed the 5.9-point drop in the ISM manufacturing survey’s new orders component to 49.2 last month. The sub-50 reading signals contraction. The employment component also remained below 50, suggesting a decline in manufacturing hiring in June. More broadly, the ISM manufacturing index slid to its lowest level in nearly two years. Some positives in the release were signals of further reprieve in supply, with order backlog, supplier deliveries and prices paid all moving lower. But overall the ISM survey for June emphasizes it is not just consumers but investment spending that is starting to weaken as well

• The final revision to Q1 US GDP data was released this week, and it showed that the economy contracted at an annual rate of 1.6%, slightly more than reported earlier.. Part of the revision was due to a lower estimate of US consumer spending, spending that grew at a 3% annual rate during the quarter, down from 3.7% in the prior revision, suggesting a weaker handoff to Q2, a period in which consumer confidence was hit hard by jumps in food and energy costs following the Russian invasion of Ukraine

• The US Supreme Court ruled that the US Environmental Protection Agency exceeded it authority in restricting greenhouse-gas emissions from power plants. Important issues that have major economic and political significance require explicit authorization from Congress, the court ruled in a 6–3 decision. In recent decades, presidents of both parties have often bypassed Congress while expanding the regulatory power of the executive branch, a trend that will now likely reverse

• The major indexes surrendered a portion of the previous week’s strong gains, as worries grew that the Federal Reserve’s fight against inflation would push the economy into recession. The S&P 500 Index closed out its worst first half of the year since 1970, as was widely reported, although the decline was amplified by the index reaching its all-time high on January 3. Typically defensive segments within the index, such as utilities and consumer staples, held up best, while consumer discretionary and information technology shares were particularly weak. Markets were slated to be closed on Monday, July 4, in observance of the Independence Day holiday

• In terms of data release, the ISM Services is out on Wednesday. The ISM services index slipped to 55.9 in May, the lowest level since February 2021. Despite the drop, the overall index remains above the 50-breakeven level, which suggests services activity is still moderately expanding. Of the index’s sub-components, notable declines came from backlog of orders (-7.4), supplier deliveries (-3.8) and prices paid (-2.5), all of which suggest supply chain pressure may be abating. With inflation as one of the most cited problems facing businesses today, incremental easing in lead times and input prices is a welcome development

• Trade balance is out on Thursday. The U.S. trade deficit narrowed to $87.1 billion in April, a sharp retreat from its all-time record of $107.7 billion in March. International trade data have been exceptionally volatile recently due to lingering pandemic-related disruptions and supply-chain bottlenecks. That said, the trade gap has widened for much of the past two years as the U.S. economy has generally expanded faster than its major trading partners


• UK GDP for Q1 has come out at 0.8% QoQ and 8.7% YoY and this leaves GDP in real terms 0.7% above its pre-pandemic level. The, separately calculated, monthly GDP figures have already been indicating a potential slowdown and Q1 is the last quarter in which this level of growth is expected to occur before rising inflation, interest rates and other events take their toll. There were quarterly increases in the output produced by the three main industries – services, production and construction. Services were driven by computer programming, logistics were up by 4.9%, while travel agencies drove support services up by 3.2%. The rise in accommodation and food services (5.0%) follows the adverse impact of the Omicron variant towards the end of Q4 2021. On the negative side, health fell by 2.3% in Q1, reflecting a large fall in NHS Test and Trace (which had been free).
The difference between the real and nominal (e.g. inflation) is already significant and only going to grow over the course of this year. What is clear, is that the UK was ahead of many other developed economies in its recovery from the pandemic, being second behind only Canada in real GDP growth in Q1 2022. However, more recent forecasts from the OECD point to a potentially greater slowdown here than elsewhere over the course of the rest of the year


• Consumer prices in the eurozone rose 0.8% in June from May and 8.6% from a year ago (up from 8.1% in May), putting pressure on the ECB to tighten policy more aggressively than the 0.25% hike this month and a 0.5% one in September that the central bank has all but preannounced. Markets are now pricing in a half-point hike for July. Government subsidies for public transportation in the wake of the energy price spike helped bring the core rate of inflation down to 3.7% in June

• While hawkish ECB policymakers continued to bring up the possibility of a 50-basis-point interest rate hike as early as July, ECB President Christine Lagarde reiterated guidance for an increase of 25 basis points followed by another hike in September, the size of which depending on incoming data. At the central bank’s annual conference in Portugal, she stated that the ECB needed to act “in a determined and sustained manner, incorporating our principles of gradualism and optionality” to tackle elevated inflation. She also said that a larger increase in the policy rate would be more appropriate “if the medium-term inflation outlook persists or deteriorates.”

• Shares in Europe fell on fears that soaring inflation and rising interest rates could hit earnings and tip economies into a recession. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 1.40% lower, while Germany’s DAX Index pulled back 2.33%, France’s CAC 40 lost 2.34%, and Italy’s FTSE MIB dropped 3.46%. The UK’s FTSE 100 Index declined 0.56%, supported by a weaker British pound against the U.S. dollar


• The official manufacturing and services purchasing managers’ index (PMI) both rose above 50 in June as a drop in new omicron infections allowed the government to ease restrictions. The manufacturing PMI reached 50.2 in June, up from 49.6 in May, while the nonmanufacturing PMI rebounded to 54.7 in June from 47.8 in May. Meanwhile, the Caixin/Markit PMI survey, a private survey that focuses more on smaller firms in coastal regions, showed manufacturing activity expanded at the fastest pace in 13 months in June. Other data showed that profits at China’s industrial firms fell 6.5% in May from a year ago, better than the 8.5% drop recorded in April. The latest PMI readings suggest that supply chain distortions have been reduced, though weakness in PMI readings for steel and construction suggested ongoing pressures from China’s housing downturn

• The People’s Bank of China (PBOC) said it would employ structural policy tools to boost confidence in the economy following the central bank’s quarterly monetary policy committee meeting. Some think the PBOC’s latest guidance was dovish and that stabilizing employment and prices remains a priority for the central bank

• The yuan currency weakened to CNY 6.70 per U.S. dollar late Friday from CNY 6.69 last week, Reuters data showed. The 10-year Chinese government bond yield rose slightly to 2.847% from 2.816% a week ago, according to Dow Jones, as issuance increased. The sale of Chinese local government bonds for June is estimated to reach a single-month record high of CNY 1.93 trillion, reported the state-backed China Securities Journal

• Chinese stocks advanced on the back of strong factory data and easing coronavirus restrictions for travelers. The broad, capitalization-weighted Shanghai Composite Index rose 1.3%, and the blue chip CSI 300 Index, which tracks the largest listed companies in Shanghai and Shenzhen, gained 1.6%, Reuters reported

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