U.S. Quarterly Economic Forecast
Threading the Needle
Date Published: September 20, 2022
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The global economy is slowing and there is no single factor behind the lethargy. In Europe, an energy crisis is battering household finances and weighing on industrial output. China is reckoning with the fallout of its real estate slowdown and strict COVID controls. In North America, central banks are rapidly tightening policy to cool the surge in inflation powered by a return of post-lockdown consumer activity and excess savings. Monetary authorities around the globe have their work cut out for them, with increasing questions on whether they can pull off a soft landing: reduce demand enough to wrestle inflation down from 40-year highs, without crashing their economies into a deep or prolonged recession.
Adding it all up, the global economic outlook has been downgraded. Although Europe is careening towards a recession, we are often asked if we are forecasting the same for the U.S. and Canada. It’s the wrong question to ask. The forecast embeds a two-year period of stagnation, with momentum holding meaningfully below the long-run trend alongside a rising unemployment rate. The duration reflects the needed dynamics to take pressure off demand-push inflation. In the event that economic momentum gets thrown into reverse, this could shorten up the adjustment period on inflation. Either way, it’s not going to feel good. There’s no easy exit from this cycle.
This publication focuses on the numbers, but if you’d like a deeper dive into underlying issues please see our Question & Answer piece published August 17th.
- Compared to our June forecast, we have marked down global growth 0.1 percentage points, taking it to 2.8% in 2022 (from 2.9% previously). The outlook for 2023 has deteriorated substantially, with growth expected to advance 2.2% – down from 2.7% in June.
- The deepening energy crisis in Europe is expected to buckle the economy as the year progresses. Limited natural gas supplies reflects a supply-side shock that ultimately reduces the productive capacity of the economy. Establishing new energy supply lines will take time. In the interim, some firms will be unable to operate, and others will face higher energy input costs that compress margins. Given the backdrop, ongoing fiscal support for worker retention schemes and to offset rising gas costs will be critical to mitigating the reduction in labor demand, but is unlikely to prevent it.
- In China, below-trend growth is set to continue through 2023 as depressed consumer confidence and the sagging real estate market weigh on output. Moreover, soft export growth amid weaker demand from advanced economies will offset the competitive benefits of a weaker renminbi. That said, a policy pivot could counter the decidedly gloomy outlook. For instance, further relaxation of COVID containment policies and additional support for the real estate market can help to restore consumer confidence, but we’re not overly confident that the government will embrace that pivot. If it does, it would help lay the foundation for a stronger bounce-back in 2023.
- U.S. economic growth disappointed through the first half of the year, with the average of Q1/Q2 growth contracting by 1.1%. This outcome was at odds with other measures of economic activity – such as gross domestic income – that showed an expanding U.S. economy over the same period. Neither measure is perfect, and the reality likely lies somewhere in the middle. Either way, the slowdown in domestic demand has not been sufficient to take the heat off inflation, which continues to surprise to the upside. This has led us to expect a more aggressive path for monetary tightening through the remainder of this year. Likewise, we have revised down our economic growth forecast for 2022 to 1.6% (from 2.2%) and 2023 to 0.7% (from 1.4%).
- The U.S. consumer has shown a degree of resilience in the face of rising inflation and higher interest rates. Consumer spending growth has hovered around a trend pace (1.9%) through the first half of 2022. If a soft landing is achievable, consumers hold the lynchpin. Our near-term tracking suggests spending will hold somewhere in the 1%-1.5% range through the second half of 2022, before slowing to a 1% pace in 2023 as household’s are further squeezed by higher rates and weaker employment growth. However, excess savings and student debt relief (which has not been incorporated into the forecast) offer some upside.
- The pace of job growth has defied gravity through 2022, and various indicators point to continued momentum over the near term. However, the labor market will not remain immune to the Fed’s rapid rate hike cycle. Job growth is expected to cool through 2023, putting upward pressure on the unemployment rate. We expect the unemployment rate to rise by 150 bps – peaking at 5.1% by the end of 2024.
- Inflation is showing more persistence across both goods and service categories. This has led to an upward revision to the near-term inflation outlook and more persistence. Core PCE inflation is still expected to cool over the next year in response to weakening demand – reaching 2.7% y/y by the end of 2023 – but it will still be sitting above the central bank’s target. The move back to 2% will prove to be far slower, with core PCE not expected to reach 2% until early-2025.
- Excess demand and multi-decade high inflation have central banks determined to lift rates further into restrictive territory. We expect the Federal Reserve and the Bank of Canada to hike their policy rates to 4% by the end of 2022. Both short-term and long-term yields will rise over the coming months on the back of higher policy rates and higher term premiums, with 10-year yields expected to eclipse 3.6%.
- The Canadian dollar may see some appreciation versus the U.S. dollar over the coming months if the risk-off move in financial markets eases, and the Canadian economy can maintain its outperformance on the GDP front. The euro and pound will be dependent on the geopolitical environment and these currencies appear to have some further downside in store given the threat to natural gas supply over the coming winter. We are pessimistic on EM currencies relative to the USD, given weakness in their respective economic recoveries.
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